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Tag Archives: Commodities

Apples to Oranges – The Case Of Commodity Indices

commodity indicesCommodity investing dramatically increased in popularity with both institutions and retail investors in the last decade as it became cheaper and easier to invest in the asset class.

 

The two primary indices for commodity investing have been the S&P GSCI and the Bloomberg indices.  These indices are dramatically different in terms of weighting structure with the S&P GSCI being very energy heavy (63% weight) while the Bloomberg index tends to be more balanced across the primary commodity sectors. As a consequence both indices can have significant performance differences.

Both indices aim to cover the broad spectrum of most actively traded commodities.  Commodity pricing is primarily determined by global supply and demand conditions, but that is where the similarities among  commodity sub-groups often end.

When investors think of constructing their portfolios usually the starting point are broad asset classes such as stocks and bonds.  Asset classes tend to possess fairly well defined risk and return characteristics and represent aggregations of “similar” investment types.

As an example, stocks are usually broken down into economic sectors but most investors would agree that stocks are driven to a large extent by what happens to the broad equity market.  Similarly, while fixed income investments are frequently broken down by maturity and credit worthiness, the key driver of fixed income returns tends to be the general direction of government bond rates.  In general, return correlations within asset classes such as stocks and bonds tend to be high and frequently exceed 0.8.

commodity correlationsWhen evaluating investment returns within the commodity complex the high within asset class correlations typically seen among stock and bond investments are absent.  More common are correlations in the 0.2 to 0.4 range.

The low correlation among commodity groups is a manifestation of a less homogeneous asset grouping than typically seen for other broad asset classes such as equities and bonds.  Given that each commodity group has its own supply and demand dynamics and the vastly different swing pricing factors this result is to be expected.

Thinking of commodity investing as a broad concept has been useful for investors as a way to get their feet wet, but given the current depth of commodity markets, the variety of liquid investment vehicles available, and most importantly the dissimilar behavior within the commodity complex we think that looking at the space as one homogeneous asset class is like comparing apples to oranges. 

Other sections in this report include:

  • Thinking of commodity return behavior in terms of risk exposures
  • What do the risk estimation exposures tell us about commodity sub-group behavior?
  • What does our research imply for commodities in the context of a multi-asset portfolio?

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Eric J. Weigel

Managing Partner, Global Focus Capital LLC

Feel free to contact us at Global Focus Capital LLC (mailto:eweigel@gf-cap.com or visit our website at http://gf-cap.com to find out more about our asset management strategies, consulting/OCIO solutions, and research subscriptions.

DISCLAIMER: NOTHING HEREIN SHALL BE CONSTRUED AS INVESTMENT ADVICE, A RECOMMENDATION OR SOLICITATION TO BUY OR SELL ANY SECURITY. PAST PERFORMANCE DOES NOT PREDICT OR GUARANTEE FUTURE SIMILAR RESULTS. SEEK THE ADVICE OF AN INVESTMENT MANAGER, LAWYER AND ACCOUNTANT BEFORE YOU INVEST. DON’T RELY ON ANYTHING HEREIN. DO YOUR OWN HOMEWORK. THIS IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSIDER THE INVESTMENT NEEDS OR SUITABILITY OF ANY INDIVIDUAL. THERE IS NO PROMISE TO CORRECT ANY ERRORS OR OMISSIONS OR NOTIFY THE READER OF ANY SUCH ERRORS.

Less Bunny, More of a Rocky Balboa Market!

Rocky Balboa View

Rocky Balboa View

The start of the year felt like a Rocky Balboa fight.  Risky assets were absolutely pummeled during the first 6 weeks of the year and were down for the count.

Most investors were taken by surprise by the strength of the first punch and the retail section started emptying out early. White towels were being thrown about but out of nowhere equity markets started gathering strength.

Just like a fighter on the ropes biding time equity markets started little by little chipping away. By the end of February stocks had stabilized and the first real signs of a competitive fight emerged during the first week of March.  The point count had evened out and by the end of the month the count had swung around in many categories. At the end of Q1 world equity markets were essentially flat but there were surprises galore.

The biggest surprise by far this year has been the re-emergence of Emerging Market Equities.  The asset class had been left for dead after many years of disappointing returns, but this year the asset class is punching above its weight – already up 4.4% (MSCI EM).

Q1 2016

Q1 2016

EM equities have vastly out-performed developed markets especially those in Asia and Europe.  A 9% gap has developed between developed and emerging international stocks (MSCI EAFE).

Despite the poor showing of the average Chinese stock how is it possible that EM equities as a whole are up for the year? No doubt investors are somewhat stunned by the YTD eye-popping returns to resource-oriented markets such as Brazil and Russia.

In our sample of global equities the average Brazilian stock is up over 24% while the average Russian equity is up about 16%.  South Africa, another major EM market, punches in at an average stock return of close to 14%.   Other emerging markets with average YTD returns exceeding 10% include Indonesia, Turkey, Chile and Malaysia.

Commodity markets have no doubt recovered, but is the strong performance of EM simply due to a recovering commodity market? 

Precious metals have done very well this year with gold up 15% and silver up 9%.  While $20 oil is still mentioned from time to time, energy markets have had a tenuous recovery but still show losses close to 10% for the year.  Smaller components of commodity indices such as grains, livestock and industrial metals are all only slightly above water this year. Our conclusion is that there is more to the re-emergence of EM equity markets than simply a direct benefit from recovering commodity markets.

While broad based equity indices have gyrated at times like a punch drunk Rocky Balboa behind the scenes we have been witnessing a strong rotation toward out of favor sectors such as Energy, Materials, Utilities and Telecom.  Momentum sectors of the past few years such as Health Care and Technology have receded.

The country and sector performance numbers indicate to us that global investors have been quietly changing their stripes.  Glamour sectors and equity markets with the best post-Financial Crisis performance are being re-priced.

2016 q1 factor perfPart of this shift toward more value-sensitive sectors and regions may be driven by a desire to better protect the downside and capture yield in what most strategists would agree is a low capital market return environment.

We perceive that investors are changing their stripes.  Valuation levels are being more carefully examined.  Investors are also showing a desire for lower risk both from a return as well as financial statement perspective. Momentum strategies have lost their punch as have sell-side analyst recommendations.

Many of the characteristics typically associated with larger capitalization companies such as lower volatility, higher yields, stock buybacks and higher levels of profitability seem to be gaining favor among global equity investors.

We see global markets being more similar to Rocky Balboa – at times exhausted and bloodied but despite great hardships triumphant in the end.  For the foreseeable future we see ourselves living in a risk on/off world with investor preferences increasingly tilted toward capital preservation strategies.

Click here to download the report: Less Bunny, More of a Rocky Balboa Market

Sincerely,

Eric J. Weigel
Managing Partner and Founder of Global Focus Capital LLC

eweigel@gf-cap.com

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Can This Russian Bear Learn To Samba?

I have my own moves!

Last week we wrote about the amazing year to date performance of the Brazilian equity market. Despite all the awful headlines and negative investor sentiment the Brazilian market was up over 20% and last week it went up a further 4%.

A similarly widely disliked equity market fraught with negative headlines having a great start to the year is Russia.

Russian equities were up 2.5% last week and in 2016 they are up about 11%. Not bad for a market that like Brazil comes with lots and lots of baggage.

All resource-oriented equity markets have benefited from the resurgence of commodities and both economies are expected to contract further in 2016, but Russia and Brazil are not cut from the same cloth.

There are at least three key differences that investors should note before lumping these emerging markets together:

  • Economic Sector Composition
  • Fundamental Drivers of Return
  • Value Add of Top-Down versus Bottom-Up Implementation Approaches

Click to read the full report  Can This Russian Bear Learn To Samba?

Sincerely,

Eric J. Weigel
Managing Partner of Global Focus Capital LLC

eweigel@gf-cap.com

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Surprise – The First Gold Medal Goes to Brazil!

gold medal-1589651With all the bad news coming out of Brazil investors must be perplexed by the strength of the Brazilian equity market this year.  After a strong jump up last week in both equity prices and the Real, the MSCI Brazil index is up 20% for 2016.  

The news last week was not good. It was reported that GDP growth clocked in at -3.8% with little hope for a rebound this year.  The Zika virus keeps wreaking havoc on the local population, Olympic Game preparations are over-budget and behind schedule, and lastly Ex-President Lula De Silva was detained in a corruption scandal involving the country’s largest company Petrobras.

Capital markets are unforgiving to those foolhardy enough to believe that short-term predictions can be made with any accuracy and the example of Brazil hammers home the point. Just when you think that certain investments are basket cases with no hope things turn around.

A great example of this happened last week in global capital markets.

AA_WEEKLY_HMAP

Now, I am not all that confident that Brazil is out of the woods yet and in fact our country allocation model rates Brazilian equities toward the bottom of the pack.

The point is that capital markets are always full of surprises.

When do we get the biggest surprises? Usually when the consensus view is at an extreme.

After the walloping that commodities and emerging market investments have been taking in the last few years, it is not too surprising to find investor sentiment heavily skewed against these beaten up sectors.

Click here to download the report: EM & Commodity Resurgence

Sincerely,

Eric J. Weigel
Managing Partner and Founder of Global Focus Capital LLC

eweigel@gf-cap.com

 

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