Commodity prices have been heading lower for more than four years, and according to data accessible via Bloomberg, commodities have been the worst performing asset class of 2015, with the most severe losses in cyclical commodities, such as oil and industrial metals. Based on the Bloomberg Commodity Index, the commodity asset class is now down roughly 50 percent from its 2011 high.
It’s no wonder, then, that many investors are asking me: Have commodity prices reached a bottom? My take: It’s still probably too early to call a bottom.
As I write in my new Market Perspectives paper, “Can Commodities Come Back?”*, commodities have been hurt by several, interrelated supply and demand trends, none of which appears to be going away anytime soon.
Demand has suffered as global growth has slowed, particularly from commodity-intensive emerging markets. Slower global growth has also been associated with a severe drop in inflation expectations. Since commodities are viewed as a hedge against inflation, this drop has led to a collapse in investor demand. In addition, commodities have struggled under the weight of a stronger dollar, a trend likely to continue given long-term global trends such as divergent monetary policies. Dollar bull markets typically last six to seven years.
The supply side of the equation has also been challenging, particularly for energy. A greater than 50 percent reduction in the U.S. rig count has only just started to slow U.S. domestic oil production. As shale producers improve efficiency, production has risen. Today, the United States produces roughly 300,000 barrels per day (bpd) more than a year ago. At the same time, following the tentative nuclear accord with Iran, many Gulf states are ramping up their own production in what appears to be a somewhat desperate effort to maintain market share.
To be sure, the supply and demand situation can change quickly, particularly for oil, and lower prices are having an impact on demand. Still, most of the factors that have put commodity prices under pressure are likely to remain in place through the remainder of this year.
Given this, I’m not expecting an imminent, or strong, rebound in prices this year. Oil, for instance, should level off around current levels, but it’s hard to imagine a strong rebound in the absence of a sharp reduction in non-U.S. production.
What are the implications for investors? All of this leaves the commodity producers as a more interesting opportunity than the physical commodities. For investors with a longer-term view, say three to five years, some bargains are beginning to emerge.
However, investors need to exercise selectivity. While most commodity-related stock sectors are cheap, the plunge in valuations tends to track diminished fundamentals, i.e. falling earnings and profitability. This suggests that commodity prices may need to move even lower or, alternatively, fundamentals need to start improving, before commodity companies become a genuine bargain.
That said, I do see some relatively attractive valuations among U.S. drillers, U.S. refiners and U.S. metals and mining firms.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.