We asked John LaForge, head of Real Asset Strategy for Wells Fargo Investment Institute, about the commodity markets and their impact on investors and consumers.
Q: What are commodities, and can they be an important investment?
LaForge: Commodities are raw materials or basic agricultural products such as oil, gold, copper, wheat, soybeans, and corn. They’re fundamentally different from stocks. Commodities, as a group, are one of the few investments that historically move in the opposite direction of stocks. When commodity prices are moving up, stocks are often moving down, and vice versa. For this reason, commodities can be an attractive addition to a diversified portfolio over time.
Q: What’s the most important commodity from an investment standpoint?
LaForge: Oil is probably the most important commodity. It is produced more than any other commodity, and its price has a large impact on the global economy, and thus on U.S. consumers. It’s also very versatile. Oil can be turned into gasoline, diesel, jet fuel, heating oil, and tar. It’s also used in chemical processes to make plastics and other materials.
Q: Do commodity prices move in predictable cycles?
LaForge: Commodity prices have historically moved together over long multi-year time periods called “super-cycles.” Commodities are often moving together in either a bull super-cycle (prices moving up) or a bear super-cycle (prices moving down). We’ve been in a bear super-cycle since 2011. The average bear market has lasted nearly 20 years, based on data that goes back to the year 1800.
The good news is that most of the price “damage” during commodity bear super-cycles has historically occurred in the first five years. With 2016 being Year 5 in this cycle, we suspect that most of the price damage to commodities has likely occurred. Using history as our guide, the remaining years during commodity bear super-cycles have typically ushered in a period where prices stay within a set range, or what is called being “range-bound.” Price bounces do occur during bears, but they’re typically short-lived.
Q: Where do you think the price of oil is headed?
LaForge: We saw oil reach a major low of $26 a barrel in February. If this cycle acts like the last bear super-cycle from 1980 to 1999, then the price of oil should see a decent bounce. Our best guess is that oil spends much of the rest of 2016 bouncing between the mid $30s and mid $40s a barrel. Keep in mind, however, that this short-term bounce needs to be taken into the super-cycle context. We expect oil prices to largely remain range-bound for the next few years, as they typically do during the middle and last stages of commodity bear super-cycles.
We’re expecting something in the $30–$60 range per barrel over the coming years. Gas prices typically follow the price of crude oil, so we’d expect to see higher gas prices by the end of 2016. But the bear super-cycle should keep gas prices from going too high.
Q: Are low oil prices good or bad for the economy and stocks?
LaForge: Whether lower oil prices are good or bad depends on the investor’s time horizon. In the short term, when oil prices are falling dramatically, the reaction by stock markets is typically negative. The reason is that falling oil prices are often a reaction to perceived weakness in the economy. So, in the short term (less than a year), investors often link falling oil prices with a poor economy, which ties to poor stock performance.
In the intermediate or longer term (greater than a year), however, the economic impact of dramatically lower oil and gas prices is often positive. The consumer can, and often does, benefit. The prices of many consumer goods, from food to clothing to the packages they come in, often fall, too. The economic impact can be large, as roughly two-thirds of the U.S. gross domestic product (GDP) is driven by the consumer.
Q: What impact does China’s economy have on commodities?
LaForge: A significant one. For much of the past 30 years, China’s impact on the commodity markets was felt most in metals prices, because that country’s GDP growth was driven by roads, bridges, and other capital expenditures. In the past few years, however, China has started to shift GDP growth away from capital expenditures and toward consumers. We’re expecting that China’s GDP shift will begin increasing overall food consumption, which could pressure grains and drive other food prices higher in the coming years.
Read the latest ‘Ask the Institute’ report on commodities (PDF) at the Wells Fargo Advisors website. See the other Ask the Institute reports in the series.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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