The End Of A Dark Decade For Energy Commodities

Beaten-down commodity markets may be tempting investors to start adding the asset class to their portfolios as they seek to diversify even as the epic stock market bull run continues to divide opinion. After years of underperformance, the broad commodity market finished the year with an impressive 17.6% gain, leading to a cross-section of experts calling an end to the eight-year bear market.

However, we might need to pump our brakes here before going all in.

Although all major asset classes finished the year in the black, individual commodity returns were all over the map with the pivotal energy sector again emerging as the worst performer.

A more nuanced view of the most widely traded commodities reveals a rather soft underbelly, suggesting that the market is not out of the woods yet.

The Bloomberg Commodities Index (BCOM), the most widely used benchmark for the commodities market tracked by 23 exchange-traded contracts on physical commodities and approximately $85 billion in assets, finished the year with a mere 3.9% gain and is down 2.6% year-to-date.

The energy sector is the most heavily represented in BCOM with a 30.34% weighting, though gold is the best represented individual commodity with a 12.24% weighting.

A decade of commodities

The price movement of most commodities has historically been both seasonal and cyclical.

Peering at the 10-year charts of leading commodities reveals a clear pattern of mean reversion where prices tend to oscillate backwards and forwards towards their mean or average. This fact alone lends some credence to the so-called commodity supercycle and offers the bulls some hope that it might not be long before the good times return.

Here are the biggest winners in the space over the past decade:

#1. Palladium

Palladium has been the best performing commodity over the past decade, posting the best returns for the third straight year in 2019; the highest returns in 5 out of 10 years while also providing positive returns 80% of the time. The commodity finished last year with a 54.21% gain, or triple the average for the commodities sector.

Palladium prices have nearly doubled over the past year and climbed more than 500% over the decade due to robust demand thanks to the metal’s ability to reduce harmful emissions in petrol-driven vehicles with a shift from diesel to petrol in full swing. Russia and South Africa are the biggest producers of the commodity where it’s obtained as a by-product in the mining of various metals such as platinum and nickel.

Demand for palladium has for years outstripped supply with the shortfall expected to continue due to production in South Africa - responsible for supplying 40% of global demand - falling drastically.

#2. Crude Oil

Long-suffering energy investors might not feel like it, but oil was the second-best performing commodity in 2019 thanks to easy comps after prices sunk to multi-year lows in 2018. Crude oil prices gained 34.5% on the year, but remained stuck in limbo for the better part of the year due to a multitude of catalysts pulling in different directions.

Oil has managed to post positive returns in 6 out of 10 years though by a significantly smaller magnitude than palladium.

Crude oil prices are down 4.1% in the year-to-date as tensions between the U.S. and Iran continue to dissipate; the US and China signed the Phase One Trade Deal while crude supply is expected to continue outstripping demand, thus leading to an inventory build despite generous OPEC cuts.

#3. Nickel

Nickel prices were a real rollercoaster last year, rallying 55% from June through September due to supply concerns before giving up a good chunk of the gains after Indonesia, the world’s largest supplier of nickel ore, resumed exports. Nevertheless, the metal was still able to finish the year with a 31.55% gain.

The vast majority of nickel supply goes to steel production with China alone accounting for 54% of global nickel demand. Nickel prices have been exceptionally volatile over the past decade mainly due to supply/demand dynamics with prices climbing steadily due to supply shocks after Indonesia introduced an export ban on unprocessed nickel in January 2014. A period of sustained destocking since March 2016 both at the London Metal Exchange (LME) as well as the Shanghai Futures Exchange (SHFE) has also been supporting prices

Platinum managed to finish the year 21.48% up despite the metal increasingly falling out of favor as consumers shift away from diesel cars, which mostly use platinum in their catalytic converters, to petrol-driven vehicles, which use palladium.

Nevertheless, prices have remained buoyant in recent times as geopolitical tailwinds boosted safe-haven demand while the effects of the dieselgate meltdown have begun to moderate. The semi-precious metal is up 5.4% YTD.

#5. Gold

As a leading safe-haven asset, gold has, unsurprisingly, been the least volatile among the 14 commodities tracked by US Global Investors. Unfortunately, this also means that the yellow metal has tended to lag other asset classes for long periods.

Thankfully, that malaise seems to have come to an end with gold finishing the year on a 18.31% gain, the 5th best among the group. Despite the impressive gains last year, the gold outlook remains quite bright with prices up 1.7% in the year-to-date. John Roque, an analyst at Wolfe Research, has told Barron’s that $1,900/oz gold remains in the crosshairs as a weakening dollar, increased buying by the world’s central banks and growing political tensions support higher levels.

#6. Silver

Like gold, silver seems to have never truly found its feet after the mega-rally of a decade ago. However, 2019 proved to be a good year for precious metals in general and silver did not disappoint either after tucking on gains of 15.21%.

Yet, the silver rally could just be getting started. David Morgan of the Morgan Report says the silver-to-gold price discrepancy suggests that silver still has plenty of room to run with one analyst predicting silver price of 28/oz in 2021, or 57.6% upside to current price of $17.77/oz.

#7. Copper

Copper prices and those of many industrial metals remained muted for much of 2019 due to fears about an economic slowdown and rising geopolitical uncertainties. Copper managed to finish the year with a 3.3% gain, slightly above the London Metal Exchange index of six base metals.

Luckily, copper and its peers have received a boost after the US and China inked a preliminary trade deal with Reuters reporting that fund managers have become bullish on the metal once again after remaining on the sidelines for nine months.

Worst performers

No less than five commodities tracked by US Global Investors finished the year in the red with base metals, unsurprisingly, well represented. Here are the worst performing commodities over the past decade.

#1. Natural Gas

Natural gas prices plunged 25.54% in 2019 making it the worst performing commodity. Unfortunately, the selloff shows no signs of slowing down with gas prices declining nearly 9% YTD.

Natural Gas (Henry Pub) Price YTD Change (USD per MMBtu)

Natural gas prices have hit four-year lows thanks mainly to persistent shale oversupply. Unfortunately, Nick Cunningham of Oilprice warns that a correction might not be coming any time soon due to lackluster demand and unresponsive markets.

The mid-and-long-term outlook, however, might be better as more coal-powered plants switch to natural gas due to its lower environmental footprint.

#2. Coal

With the ESG drive in full swing and megabanks increasingly balking on coal investments, it’s perhaps safe to say that the halcyon days when coal prices were rallying in triple-digits are over.

Coal finished as the second-worst performing commodity after prices fell 18.02% and has been the most volatile of any commodity. Perhaps this is to be expected as coal power generation falls out of favor and production capacity continues to dwindle as per the latest EIA report.

#3. Zinc

Like many industrial metals, zinc prices have taken a hammering, tanking 9.5% in 2019 due to trade tensions and a synchronized slowdown of the global economy. Prices, however, have rallied 6.3% in the current year.

Zinc Price YTD Change (USD per Ton)

The International Lead and Zinc Study Group (ILZSG) has forecast a rise by 0.9% in zinc demand in 2020 to 13.80 million tons with China demand expected to surge 1.2%

Lead demand, however, is expected to continue being soft.

Bottomline

While it’s entirely possible that we are witnessing the first innings of a commodities bull market after the removal of several major overhangs, an attitude of guarded optimism is advised. With the global economy still on shaky ground, the commodity markets are likely to continue facing weak demand and downward pricing pressure.

On the other hand, with the brawny greenback widely expected to weaken from here, a broad class of commodities, especially precious and industrial metals, could benefit.

By Alex Kimani for Oilprice.com