According to research from groups such as Global Data, the current prices in the market are not acting as a deterrent because the profit margin on most commercial unconventional oil plays will support prices as low as $50 while many are even below that threshold. In other words, US shale producers can keep pumping oil economically even if Brent dropped to $60 a barrel. In fact, industry experts believe that Brent would need to remain at $50 a barrel for 12 months for North American shale output to drop by 500,000 barrels a day.
LEAKING ASSETS
Given the backdrop, it is no wonder that investors have remained wary. Last year, figures from Barclays revealed that they withdrew a net $47.1bn from commodity markets, with the bulk of outflows – around $40.7bn – emanating from gold-related products. However, the base metal, agricultural and energy-related sectors also experienced withdrawals. Outflows continued this year at a slower pace in the first half but they accelerated in September with ETF Securities showing assets under management in exchange-traded products (ETP) backed by commodities plummeting by more than 10% to $110.7bn in the third quarter – their lowest level since the beginning of 2010.
Overall the top 10 commodity managers suffered a 3% drop in pension fund AUM to $40.4bn in 2014, according to Towers Watson. This has led to banks including Barclays, JP Morgan and Deutsche Bank to withdraw from the sector while many hedge funds have also joined the exodus. For example, Clive Capital, once one of the world’s biggest players, closed last year while Arbalet, BlueGold, Centaurus, Fortress and Higgs Capital wound up commodity vehicles. In addition, Schroders shut its Opus fund, which managed $2.3bn at its peak, in June.
“Institutional investors have been absent for a long time and if you put yourselves in their shoes you can see why,” says Hakan Kaya, portfolio manager at Neuberger Berman. “There has been increased correlation, structural problems in China and strong performances from equities and alternatives. This has led to a rotation away from commodities starting in 2011. However, I believe that the performance chasing will end and that inflows will restart as investors reassess the fundamentals and strategic reasons such as de-correlation and diversification. Most commodity markets have sold off to multi-year lows and we believe they should be looked at as value assets with attractive fundamentals.”
One of the main challenges though is investors’ fixation on China’s slowing economy, according to James Sutton, client portfolio manager for natural resources at JP Morgan Asset Management.
“There is not enough understanding of the supply and demand dynamics driving the different commodities. For example, as China moves to a more consumer-led economy, the demand profile for certain commodities will improve. This is the case with diamonds in the precious metals and minerals group. Although it is still early days, engagement rings in the country are becoming more popular and a classic supply constraint supply story is emerging which is pushing prices higher.”
Andrew Kaleel, director of global commodities/ managed futures at Henderson Global Investors argues that the ‘case for commodities’ being included in a diversified portfolio is still as relevant today as it has been for the last two decades (the period in which commodities have become a mainstream and readily investable asset class). “While past returns, as always, are no guarantee of future performance, we believe that an allocation to commodities among other classes provides potential inflation, tail risk and geopolitical hedges through this one asset class,” he says.
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