Digging into oil, gold, and other commodities

Oil spills volatility. Gold seeks strong close after putting bear to bed. Agriculture sprouts price weakness.

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Commodities (i.e., raw materials that are used in the production process for most products) have been in a long-term downtrend for several years. The Bloomberg Commodity Index has lost 53% since March 2011 (see the chart below).

However, thus far in 2016, oil, gold, and other commodities have, for the most part, broadly rebounded. The Commodity Index has risen more than 7% year-to-date, outpacing the 6% price return of the S&P 500® Index, as of September 27, 2016.1

If you own or are considering investments in parts of the market that are influenced by commodity prices (such as the energy and materials sectors), analyzing how they may perform can be a useful fundamental data point to help inform your investing strategy (see sidebar).

But, investing directly in commodities is complex. If you are considering adding this exposure to you portfolio, you may want to consider professional management.

Here’s a look at how several commodities have performed recently, along with expert commentary from independent research providers on the energy, metals, and agriculture markets, which are one of many resources that you can use to evaluate this part of the market.

Oil: Potentially range-bound

It’s been a volatile year in the energy market. Crude oil is currently trading around $44 per barrel, as of September 27, 2016, but prices have fallen as low as $35.99 and risen as high as $51.81 this year.1 In the third quarter, oil prices dropped roughly 10%, as of September 21, after gaining 32% during the second quarter (see the chart below).

Oil is the most heavily traded commodity in the world,2 and a critical input for a wide range of businesses—including airlines, package delivery firms, and manufacturers. For example, at $45 per barrel, fuel costs represent 20% of the operating expenses for the global airline industry, and those costs would jump to 27% of operating expenses at $55 per barrel, according to the International Air Transport Association.

Moreover, gasoline and heating oil prices can influence consumer spending, with rising or falling prices having the potential to impact a wide range of businesses from hotels to restaurants and retailers.

If you are an active investor seeking information that can help you evaluate the potential impact of energy prices on the portion of your portfolio that you manage, there are many resources at your disposal.

One prominent source of such information is the Paris-based International Energy Agency (IEA), a 29–member country organization that monitors the world energy market. The IEA attributes the modest decline in oil prices over the last several months to a combination of moderating global demand and the potential for more supply to hit the market—particularly from OPEC members Libya and Nigeria. The IEA thinks the oil surplus could last longer than previously thought as the existing oversupply will persist well into 2017 (marking the fourth consecutive year of oversupply) and as demand growth remains relatively sluggish (particularly in India and China).

Another resource that you might consider using is Fidelity.com’s markets and sectors research page, which offers independent expert commentary from several third-party research companies (login required).

For example, the Hightower Report—which is published daily on days that the stock market is open—recently noted that oil prices could remain relatively range-bound in the near term. Specifically, Hightower reports that oil prices are being driven primarily by:

  • Supply and demand: Hightower cites the most recent U.S. stockpiles report, which shows inventories for the week of September 23 at very high levels (a bearish factor). Crude stockpiles of 504 million barrels are the highest ever for this week of the year, and are 51 million barrels above levels from a year ago. On the other hand, oil prices are being supported, in part, by negotiations among OPEC and several non-OPEC countries to limit production in order to push prices higher. Hightower notes that recent comments from Russia, Iran, and OPEC members agreeing to cooperate on production limits may be moderately bullish in the short-term for oil prices, but the prospect of any long-term agreement coming to fruition is “highly suspect.”
  • Fed action: The Fed decided not to raise rates in September—a short-term bullish factor for oil prices, according to Hightower. However, Hightower notes that an eventual Fed rate hike could be bearish for oil prices due to the potential for higher rates to cause an increase in the dollar, which they believe would cause commodity prices to decline. Fed funds futures are currently pointing to about an even probability of a rate hike in December.

Gold: Looking to end its losing streak

After gold hit a two-year high in the wake Brexit, the precious metal had been in decline; Nymex gold hit a multi-month low in mid September. However, gold is still up 24% year-to-date, as of September 27, 2016, and is looking to end a four-year losing streak (see the chart below).

Some investors who are bullish on gold cite factors like the metal’s perceived role as a buttress against rising inflation, a safe haven amid increasing market volatility, and its potential for portfolio diversification. Others think of gold as a sparkly pet rock—its value is in the eye of the beholder, as gold itself does not generate cash flows. Regardless of how you view gold, the price of the precious metal does impact the performance of certain segments of the market—in particular, mining stocks within the materials sector.

The World Gold Council is an organization that provides information on the gold market. In their second quarter report, the World Gold Council noted that gold demand was the second highest on record for the first half of the year (2,335 million tons), led by significant exchange-traded fund inflows (579 million tons), which outweighed “anemic jewelry demand in an environment of sharply rising prices.” Indeed, gold prices realized their largest price increase during the first half of the year in 35 years.

The Hightower Report’s September 22, 2016, Daily Metals Commentary (available on Fidelity.com) states that gold’s price appears to be biased to the upside over the short term, after the Fed’s decision to not raise rates. “We now think that gold and silver derivative holdings will [continue] to see inflows, now that the Fed is out of the way,” Hightower’s September 22 report notes. Indeed, on the afternoon of September 21 after the Fed decision, the world’s largest gold ETF saw its holdings rise by 5.64 million tonnes, according to Hightower.

However, Hightower has reiterated in several previous reports that they believe gold will become biased to the downside from its current price of $1,341 per ounce, if a Fed rate hike does eventually occur, due to pressure from a potential appreciation of the dollar.

Industrial metals: Mostly positive

Whereas gold has multiple uses—such as in jewelry, construction, and as a financial asset—industrial metals like steel, iron, and copper are driven almost exclusively by supply and demand factors from manufacturing and construction processes. Some industrial metals have had an even better year than gold thus far (see the chart below).

Steel is an important commodity in a number of industries, including automobile manufacturing, construction, and energy production, and has undergone a significant transformation over the years. The World Steel Association reports that steel production growth rates have slowed from 7.4% per year in the early 1950s to about 2.5% per year in the 2010s, and that Asia now produces the overwhelming majority of steel around the globe (led by China at 45% of global production).

Although U.S. steel prices are up significantly in 2016, they have softened in recent months. According to a Zachs Equity Research report from September 20, found on Fidelity.com (login required), “continued weakness in the [global] manufacturing sector and the glut of foreign steel imports into the U.S.” could continue to push prices lower. The report notes that the higher prices caused global steel production to decrease 1.2% to 929.6 metric tons from January through July, as production shrank on the prospect of lower demand due to the higher prices.

Zachs notes that the steel industry is “challenged by waning investments, turbulence in the financial market, and geopolitical conflicts in many developing regions,” and that relatively “lower oil prices have pulled down prices of steel as well, given the industry’s 10% exposure to the energy sector, as steel demand from energy companies continues to be weak due to declining capital expenditure budgets.” Overall, Zach’s suggests these bearish factors could continue for steel prices in the near term.

Agriculture: Strong yields lowering prices

The agriculture commodity market may not get the media coverage of oil and gold, but crops and livestock are a critical input for a wide range of businesses, including grocery stores and restaurants, as well as having a large impact on food prices and consumer spending.

After some fairly significant supply shocks in previous years (you may recall corn prices spiking sharply in 2012, raising concerns of potentially large increases in food prices), crop yields have been very strong over the past several years, including this year. The U.S. has been on a run of good weather for more than four years, which has boosted crop production and put downward pressure on the stock prices and earnings of agriculture companies. The UBS Grains Index has more than halved since a near-term peak in July 2012 (see the chart below).

The International Grains Council, a 27-member inter-governmental organization that provides information on global grain trade, recently boosted its 2016 outlook for combined stockpiles of wheat, corn, soybeans, and other grains by 1.2% to an all-time record high of 2,069 million tons.

The Hightower Report’s Daily Grain Market Commentary from September 22, available on Fidelity.com, notes that “the continuation of very impressive yields” may continue to put downward pressure on prices for soybeans, corn, wheat, and other grains. Soybeans, in particular, have seen excellent yields, and Hightower estimates that, if good weather persists and technological development continues, soybean stockpiles will be a strong 463 million bushels by the end of 2016, with some analysts estimating they could jump to 727 million bushels in 2017, a record high.

Investing implications

Of course, you should not rely solely on any one piece of information, including expert market commentary. Instead, you can consider using the research resources like those that are available on Fidelity.com in combination with other tools in a mosaic strategy that can help you get as much information as you need to make informed decisions.

Analyzing the commodities market can be complex, and so it may be in your best interest to utilize professional research. Commodity prices can impact the entire market, and doing your own analysis on how they may perform may help you better manage your portfolio.

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Past performance is no guarantee of future results.
1. Source: FactSet, as of September 21, 2016.
2. Source: CBOE, as of September 21, 2016
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. References to specific investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. This piece may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.
The gold industry can be significantly affected by international monetary and political developments such as currency devaluations or revaluations, central bank movements, economic and social conditions within a country, trade imbalances, or trade or currency restrictions between countries.
Fluctuations in the price of gold often dramatically affect the profitability of companies in the gold sector. Changes in the political or economic climate, especially in gold-producing countries such as South Africa and the former Soviet Union, may have a direct impact on the price of gold worldwide.
The precious metals market is extremely volatile, and investing directly in physical precious metals may not be appropriate for most investors.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
All indexes are unmanaged. You cannot invest directly in an index.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with each particular industry.
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