Commodities and Commodity Investing David O’Shea Investment Director
Agenda Introduction Commodities & Commodity Markets Origins & History Commodities in a Portfolio Current Trends Case Study : Oil Market Conclusions Managing Your Portfolio & Product Showcase
How did you start your day?(through the eyes of a commodity trader) It was a little cold so you decided to turn on the heating and made a mental note to order some more heating oil for the winter months (Oil : International Identifier - CLA). You sat down at your new IKEA table & chair set (Lumber: LBA) and poured some milk (Milk : DAU9) on your cornflakes (Wheat Future: W A). You had a glass of Orange Juice (Florida Orange Juice Future: JO). You were hungry so decided to have some bacon (Pork Bellies: PBA).Finally you had a strong cup of coffee (Arabica Coffee : KCA).to get yourself set for the day.
What are Commodities and what is the Commodity Market Defining Commodities: A good for which there is demand but it is supplied without difference by producers. The word commodity refers to the fact that the product is generic. But commodities while generic do not all have the same characteristics. Most pertinent is the issue of storage.
Commodity Trading through History Glut of commodities at market time – buyers market (producers) Logistics became an issue Forward contracts were introduced to allow buyers and sellers to match their differing needs Regulation - because it is a question of trust. Economies (and funding for military armies) grow through trade so it was in the rulers interest that it was fostered.
Markets have existed anywhere there has been a desire to trade
As trade developed and led to specialisation there was a need for structure around how markets were regulated
In ancient Greece and Rome markets were held on preordained days
Forward Trading was written into Japanese law in 1730
Understanding Commodities Commodities are goods that we use in daily life. Traditionally Commodities have lagged other indicators. Basic laws of Supply and Demand are the overriding factors in driving the market Very responsive to how economies are performing and global demand is developing
The Commodity Market Open, regulated, transparent Large range of quoted commodities and exchanges Innovation continues as a good pace –example: Carbon Emissions Market. Generic Product - (so efficiencies in production are usually quickly taken on throughout the market) Non Production traders bring liquidity and efficiency and limit the existence of excessive profits
Commodities in a Portfolio Understandable Diversification Lower volatility for similar returns to equities Significant universe of exposures – each commodity is unique and has different fundamentals driving its price Traditionally Commodity Prices have been negatively correlated to other asset classes
Commodities – the black sheep of the investment markets Commodities should be a part of your portfolio
Current Trends in Commodities Significant growth in Commodity investing Correlation since the credit crunch last year is now running at all time highs. Commodities are beginning to become more forward looking More market participants and more sophisticated analysis Are Commodities the new Equity?
The Oil market is dominated by an Oil Cartel - OPEC. A small number of produces can affect supply to set prices.
Demand is unlikely to waver significantly unless renewable energy can make huge leaps forward
Consumption patterns unlikely to change and supply likely to remain constrained
What drives the Oil Market? McKinsey Report (June 2009) – GDP growth the most important factor affecting the short term growth of oil and energy. Longer term, factors such as efficient usage and increased productivity can have a significant impact.
Oil Supply & Demand Supply likely to remain an issue: International Energy Agency (IEA) forecasts a fall of 2.6m b/d. Last year we had a fall of 200,000 b/d. The first time since the 1980’s that we’ve had 2 consecutive years of contraction. OPEC has announced 3 separate price cuts since Sept to steady price falls. Much of the worlds easy oil has already been extracted. New discoveries tend to be smaller than previously. Merrill Lynch estimate that in order to maintain current output firms must find the equivalent of Saudi Arabia reserves every 2 years. Renewable energy is still not able to take up the slack Many of the largest reserves are in the hands of despots and dictators IEA forecast a cut of up to 20% in overall investment in the industry in 2009.
How will the current Crisis affected Oil Demand? Deep Recession Projection Pre-Crisis Projection
Why do we think Oil is not falling in the short term?
Consumption likely to recover in 2010
China remerging on a solid growth path (Chinese authorities have erred on the side of growth and inflation)
Recent crisis already priced in to current predictions – Oil prices are back to their long term average
OPEC members unlikely to allow Oil revisit last years lows
Real price of Crude Oil 1947-2008
Conclusions Commodities markets can add diversification while reducing risks Operating on different but understandable fundamentals - a connection with real economy Commodities markets are not a generic asset class but are multi-layered and offer investors different opportunities Commodities represent an asset class which investors should take seriously and include in their portfolios Commodities as the new equities?
Managing Your Portfolio Markets are likely to be more volatile in the years ahead and investors will need to dedicate more time to their investment portfolios or hire professional risk managers Expect the return of a more macro data focus and for asset prices to respond accordingly 4 Pillars of Investing Liquidity Transparency Risk Return