Recent pains in the commodities sector, especially in energy, have left many investors burned and hesitant to return. But they may want to reconsider their positions; an expert at Pacific Investment Company (PIMCO) predicts better times ahead.
PIMCO is a global investment firm with US$1.47 trillion in assets under management worldwide. It manages $31.9 billion in assets for Canadian clients.
“Returns in the commodities markets have improved over the past year amid stronger macroeconomic activity and supply-side tightening, and our outlook for the next 12 months has brightened,” Greg Sharenow, an executive vice president at PIMCO’s Newport Beach office and a portfolio manager focused on real assets, said in a recently published market viewpoint.
“While considerable uncertainties remain for all commodity sectors, we believe the worst market trends may be behind us.”
He cited several tailwinds. On the supply side, a recent pullback in capital expenditures has slowed down output growth for certain commodities. With OPEC curtailing oil output and China restricting its capacity in metals, supply-side adjustments over the past 12 months have favoured higher prices.
He noted strong demand growth for commodities over the past few years in spite of lacklustre economic expansion around the world. Low oil prices have kept the quantity of oil demanded above trend; as of December, demand experienced its highest two-year growth period in 10 years. An increased focus on infrastructure in both developing and emerging markets will also stoke demand for raw materials.
On the oil front, PIMCO expects OPEC to maintain its current restrictions on oil output until the end of the year, letting inventories normalize. There’s a risk of the organization not doing this next year, depending on whether or not a deal it has with non-OPEC oil producers will be renewed in May. The firm is expecting that the deal will be extended, leading to an extended tightening in oil supply. The result: “[W]e expect Brent to average in the mid-US$50s in 2017 and 2018.”
The firm predicts a growth in US demand for natural gas within the year due to several large-scale petrochemical plants going online. “This would lead to a call on domestic supply growth that producers will be unable to fulfil at current prices,” Sharenow said. “Our top-down and bottom-up production forecasts show that output is unlikely to match pipeline capacity growth and that additional upstream investment will be needed to satisfy growing demand.”
Industrial metals are expected to enjoy supportive demand growth from China, and recent underinvestment in production and rationing of supply has kept prices of the metals afloat. According to Sharenow, the firm is reasonably cautious on precious metals and least optimistic about agriculture.
“Overall we see a broadly positive outlook for commodities in the next year … With inflation risk rising and the return of commodities as a diversifier for portfolios, we think portfolio allocations that are in line with benchmark allocations or modestly overweight may make sense for most investors.”
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