Commodities & Currencies
Oil has been doing well lately, putting a smile on the faces of traders and the shale industry and a grimace on the faces of everyday Americans. Well, Barron’s says the grimace won’t go much longer, as this oil rally is bound to fade. Oil is almost back to $60 after reaching $44 in July. However, for it to move any higher the market would need to be banking on geopolitical supply disruptions, which seems like a long shot to rely on.
FINSUM: The fundamental demand and supply picture simply don’t justify prices much higher than now, so we don’t think this run will be able to maintain its momentum.
Everything seems to be in boom mode right now despite the fact that markets and the economy have been decent for some time. One very positive sign for the markets is that commodities have been on the rise despite a long period in the doldrums. Metals and energy have both been doing well despite the structural issues that have plagued the sector for years. Oversupply seems to to have been quelled in oil, and inventories of various metals, such as nickel, have shrunk, leading to a price boom.
FINSUM: High demand for commodities is a very strong sign of economic expansion, so we take this as a reliable indicator that the economy may start to deliver on all the hype. Inflation to follow?
Gold has had an interesting ride the last few years and is currently in the midst of a strong year. However, its recent performance may pale in comparison to what comes next, at least according to Barron’s. Barron’s says gold has the best risk/reward ratio of any asset class today, and that even if other asset classes keeps rising, gold investors will do well. They may really hit it big if we have another crisis, though. Additionally, fundamental factors like supply are waning, which should move the equilibrium price of gold up. The metal is up 11% so far this year.
FINSUM: Gold’s valuation certainly isn’t as lofty as many other assets classes after years of weak performance. But then again, gold’s value is so abstract it is hard to talk about valuation on a meaningful basis.
Gold has had a good year. Up 15% through early September, it had unexpectedly risen alongside shares for solid gains this year, though it has slumped considerably since. Now a slew of factors may be conspiring to take it down further. The big risk is of the Fed hiking rates even though inflation is weak. That has historically been bad for gold, as any time rates move higher it weakens gold as its zero-rate return looks less favorable. Low inflation also reduces gold’s attractiveness as a hedge, meaning a hike during a low inflation period is essentially a double-whammy against gold. Finally, rate hikes would strengthen the Dollar, another factor that would hurt gold demand by making it more expensive for overseas buyers.
FINSUM: If Yellen and the Fed stick to their rhetoric, then gold looks set for some sure losses.
You wouldn’t think it with oil prices still at only $50, but the US oil industry is humming along. In line with that, Goldman thinks that there are some good buys to be had. Investors have been warming to the oil sector, but not buying it wholesale. Instead, they have been very particular with their investments. They want discipline in the companies they are buying, with restrained capital allocation strategies, and better cash flow profiles.
FINSUM: Sentiment on oil is certainly improving. A lot of it seems to stem from more bullishness on the economy as a whole, as a better economy would presumably increase demand for commodities.
The oil market is currently caught between two competing views. On one side are those who think that oil will continue its century long boom and bust cycle, feeling that is bound to rise again. Others think that cycle has finally been broken and that oil will stay low and range bound for a long time. The argument of the latter is that shale oil has finally made the market competitive, meaning that supply can efficiently rise with demand, keeping prices stable, something that has never really happened in the oil business.
FINSUM: We think the debate over the competitiveness of supply is secondary to what we view as a false assumption of demand growth. Total oil demand peaked over a decade ago in the US and Europe. Emerging markets will likely follow the same pattern, so why is the world expecting big demand growth (especially with renewables growing quickly)?