BNP AM

The official blog of BNP Paribas Asset Management

The revenant commodities

In the film The Revenant, the character played by actor Leonardo DiCaprio survives some gruesome moments. One of these is an attack by a ‘great bear’. The movie relates the story of Hugh Glass, an American frontiersman, fur trapper and trader, hunter and explorer, in 1823. Indeed, ’traders’ had a tougher time back then than they do nowadays (or did they?…). Whether this grizzly scene (and the rest of the movie) is a true story or not doesn’t really matter.

In the film The Revenant, the character played by actor Leonardo DiCaprio survives some gruesome moments. One of these is an attack by a ‘great bear’. The movie relates the story of Hugh Glass, an American frontiersman, fur trapper and trader, hunter and explorer, in 1823. Indeed, ’traders’ had a tougher time back then than they do nowadays (or did they?…). Whether this grizzly scene (and the rest of the movie) is a true story or not doesn’t really matter.

Surviving a bear attack is also a common theme on financial markets

For the past five years, commodity markets have been in decline – a “bear” market. With a fall of more than 66% (BCOM ex agriculture & livestock TR Index from 25 April 2011 to 20 January 2016), we could describe this period as a ‘great bear’, not least if we consider that early this year we saw oil prices at a 12-year low – close to USD 27 per barrel on 2 February.

There have been some clear reasons for this plunge, such as the global economic meltdown and China’s economic slow-down. But some other less obvious reasons have also emerged: the shift to alternative energy sources, overcapacity resulting from mining projects developed during the rally of 2006-2008, and the increase in the number and capacity of US oil wells.

The commodities market has also seen a purge of the professionals who manage and play it: banks have closed or strongly reduced their commodities investment activities and book sizes since 2011. Specialist commodities hedge funds have also closed. Many investors have accepted the difficulty of timing the agricultural commodities markets, where the weather factor is anything but predictable. In short, few people have wanted to keep commodities in their portfolios.

Nonetheless, there was a rally in commodities during the first half of 2016 

It was a rally that took most traders and fund managers by surprise. Apart from the fact that very low prices generally tend to rebound at some point, the fundamentals of each commodity did not support such a dramatic rise in the price of most commodities. Indeed, there is a saying in the commodity market that prices have to remain low for a certain period of time before they can rise again. The longer they remain low, the more the physical market’s ‘invisible hand’ can adjust its capacities and the better prices will gradually adjust higher. This is how cycles work.

Whatever the case, the result is that the above-mentioned index rebounded by some 30% from the bottom up until 10 October 2016. Gold has jumped about 23% year to date, at the time of writing.

The rally has brought commodities back into investor conversations, with many saying “I told you it had to rebound”. And there have been many requests for gold investment products, once again.

So hopefully the theme of my introduction linking to commodities may now be a little clearer

At some point after a bear attack – assuming the trader lives to tell the tale! – his comeback can be impressive: he not only survived, and but is again prospering. So is this the right moment to re-introduce commodities in one’s portfolio?

Are we on the way to a more normalised commodity market? Market timing is always tricky, and such diversification assets should always remain just that – invested in for diversification purposes. Even so, now seems to be a good moment to look again at this market and to consider attractive entry points using a more strategic approach.

Our tendency would be to be neutral on commodities for the next three to 12 months

We would need the oil forward curve to flatten, with eventually a good old backwardation situation, to be fully convinced of being able to benefit from an attractive carry. Industrial metals’ fundamentals don’t show any real signs of improvement. And precious metals could be hit by interest-rate increases and a stronger US dollar. However, we believe the nature of commodities as an asset allocation hedge still makes sense as a diversification element.

So the real relationship between my introduction story and the commodity market is the film’s title: “The Revenant” (a returner from the dead). At some point, due to their cyclical behaviour, commodity prices could once again rise much higher than they are now. Although 'When' is of course the billion dollar question.

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