Another look at commodities
The price of crude oil has soared dramatically, rising by about 190% since its lows of December 1998. The main driver behind this dramatic increase has been the surprisingly concerted efforts of OPEC members to stick rigidly to the production cutbacks agreed in April 1999. The cutbacks were further reinforced through production restraint from non-OPEC members Oman, Russia, Norway and Mexico.
Other commodities, such as industrial metals, have been rising too, at a significantly lower pace while prices of ‘soft’ commodities such as grains and livestock have remained depressed. According to Goldman Sachs, the non-energy component of its Commodity Index fell some 3% in 1999. Overall the broader commodities are showing gains over 1999. According to Goldman’s global strategist Neil Williams, there are more gains to be had this year, and commodities as a separate asset class should be favoured over equities, cash and, especially, bonds. “Although energy prices, and in particular crude oil, are already at the upper end of their forecast range, the non-energy commodities sector has yet to join the party and has significant upside.”
Goldman Sachs are not alone in their bullish view of commodities. Deutsche Bank agrees that the fundamental backdrop for commodities remains favourable because of the forecast upturn in OECD industrial production which, historically at least has had a close relationship with commodity prices, and because of low inventory levels for both oil and metals. Deutsche Bank highlights the importance of OPEC’s commitment to the output cuts for the outlook for oil prices – energy accounts for half of the broader commodity indices – and argues that although risks of ‘cheating’ on quotas by producers do exist, if OPEC members decide to increase their period of restraint, then oil prices could spike even higher. This is a risk echoed by Goldman Sachs.
Fund managers seem to be putting a brave face on these reports. According to Robeco Group, it would not be in OPEC members’ own interests for the oil price to rise much more: “We believe that OPEC are satisfied as long as they keep the oil price above $22 per barrel and that the general view among OPEC members is that an oil price higher than this will, in the long run, damage their position, as it will attract further supply. We think the oil price will fall slightly.” Fund manager Bob Galesloot goes on, “Yes, commodity prices have risen sharply recently, and yes we factor these into bond models. It has scared the market into believing that inflation is back, but we do not believe that it is.”
Tony Plummer at Investec Guinness Flight thinks there is more behind the commodity price rises and argues that a synchronised phase of global growth should generally be bullish for commodities. “We have already seen a good rally in 1999, and although there may be something of a fall-back in the coming months, I believe they are set fair for a few years.” Plummer is quick to point out that this cycle of rising commodity prices should not be likened to those witnessed in the 1970s and 1980s, arguing that in those decades it was governments that were the profligates, printing money and creating speculative bubbles in commodities and precious metals. In the 1990s it has been the private sector which been creating money.
Although bullish on commodities over the next two years, or so, Plummer is still firmly in the disinflation camp. He explains: “What we are seeing is a short-term cyclical upswing within the long-term secular disinflationary trend. I believe that developments in technology have profound importance for us all, in terms of pricing powers. In addition we now have central banks working together to keep a firm grip on monetary policy, while budget deficits are coming under control. Adherence to the Maastricht criteria has forced the governments of Europe to join this way, too.”
Although a stalwart of bond markets and not normally one to enthuse over inflation anywhere, Plummer is enthusiastic about one rising commodity price, that of gold. He remarks: “Until a few months ago, there had been a huge attempt to demonetise gold, particularly by the Fed which, unsurprisingly, was fairly keen for the US dollar to be the main medium of exchange. However, after one of the Bank of England’s much-trumpeted gold auctions, the price of gold exploded upwards. I am convinced that we have now broken up into a comfortable bull market phase in gold, and silver too.” Caroline Hay