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Q1 2015 Commodities’ Impact

12/03/2014

Prior to the 2008 global credit crisis, commodities were considered an emerging asset class that was mandatory for investor portfolios. Many expected they would provide diversification and have a low correlation to the direction of the S&P 500® Index (SPX). An allocation weighting of close to 30% was suggested. Commodity index funds and ETFs levered to commodity futures markets could not be created fast enough.

In the wake of 2008, the reality is that commodities did not provide diversification and, in fact, were highly correlated to the SPX.  For evidence, take a look at the chart below of spot gold prices from 2006 through 2008. Gold, which should have been the ultimate diversification commodity, declined along with the SPX.

Spot Gold Prices, 2006-2008
Spot Gold Prices, 2006-2008
Source: Bloomberg

The title of this piece reflects how I expect investors to regard commodities. How will expected and current commodity pricing impact other asset classes? I do not expect the optimal investment strategy is to own assets that track the futures market. (Side note:  Understand that one of the results of Dodd-Frank regulations is less liquidity and arbitrage availability for the futures market. Algorithmic trading models currently dominate. Not a good environment for investors….)

So let’s take a look toward Q1 2015 and present some expectations on how commodities might impact the economy, other asset classes, and sectors.

  1. U.S. GDP should experience a temporary 20 to 30 bps positive impact.
  1. The U.S. budget deficit as a percentage of GDP should fall below 2.5%. Since oil prices peaked in late June, that figure has fallen from 3.1% to 2.8%.
  1. Consumer discretionary earnings reported should show stronger revenue growth from the “gasoline tax cut.”
  1. Energy equities may have found their bottom; however, much of the sector has become a “value trap” play and will not be appealing in a 2015 pro-growth environment.
  1. Sentiment has experienced its most dramatic shift in precious metals. In prior years, precious metals demanded headlines. Today, they are barely discussed. Consider small allocations to global mining companies, those with acquisition appeal in particular. 
  1. There is an obvious global divide between the benefit to oil importers versus the disadvantages to oil producers. The divide is not temporary and could exist throughout 2015.
  1. The sentiment for portfolio managers heading into 2015 is to own large caps over small caps when consideration to falling energy prices is given.
  1. There is elevated potential for Russia to reignite the Ukraine crisis.
  1. Natural gas allocations are not the solution simply because oil allocations are being reduced. Sustained U.S. pricing above $5 is needed.
  1. The potential Halliburton/Baker Hughes M&A deal did not support the energy sector finding its bottom as expected. I expect that agriculture equities have a better chance to appreciate than energy equities based on some form of 2015 M&A activity.

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.