The Global Battle for Commodities Panel Detail: Tuesday, April 28, 2009 2:30 PM - 3:45 PM Speakers: Mark Cutis, Chief Investment Officer, Special Situations, Abu Dhabi Investment Council Josh Eastright, Product Manager, Energy and Commodities Markets, Bloomberg LP Mari Kooi, CEO and Founder, Wolf Asset Management International LLC Mark McLornan, Founding Partner, Agro Terra Ltd. Neal Shear, Managing Partner, Apollo Commodities Partners Moderator: William Marcus, Head of Sales, Americas, Newedge Group
90
Embed
The Global Battle for Commodities - Milken Instituteassets1c.milkeninstitute.org/assets/Events/Conferences/...Crude oil Gold Total return index, December 31, 1987=100 Total return
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
The Global Battle for CommoditiesPanel Detail:Tuesday, April 28, 20092:30 PM -
3:45 PM
Speakers:
Mark Cutis, Chief Investment Officer, Special Situations, Abu Dhabi Investment CouncilJosh Eastright, Product Manager, Energy and Commodities Markets, Bloomberg LPMari Kooi,
CEO and Founder, Wolf Asset Management International LLC Mark McLornan, Founding Partner, Agro Terra Ltd.Neal Shear, Managing Partner, Apollo Commodities Partners
Moderator:William Marcus, Head of Sales, Americas, Newedge Group
Commodity price volatility was high in 2008Six-month change Standard deviation
Reserve repl. (organic) Reserve repl. (Acqns) Reserve life
Why Commodities?
Significant challenges in supply response
Global portfolio efficient frontiers, January 2003 –
March 2008
January 2003-August 2007Please note that the data above is based on CMCI Total Return Indices
Why Commodities?
Asset allocation advantages are also important
Source: UBS.
Chinese Crude Oil Imports: Jan ’04 -
Feb ‘09
Chinese Copper Imports: Jan ’04 -
Feb ‘09
Why commodities? Conflicting signals out of emerging economies
Source: Bloomberg.
April 13, 2007
WTI = 63.63
April 13, 2008WTI = 110.11 April 13, 2009
WTI = 50.05
NYMEX CurveHigh AnalystLow AnalystAvg. Analyst
Why avoid commodities? “Experts”
have all but thrown their hands up
Source: Bloomberg.
By Linda Sandler, Yuriy
Humber and Christopher ScintaApril 14 (Bloomberg) --
Lehman Brothers Holdings Inc. issitting on enough uranium cake to make a nuclear bomb as itwaits for prices of the commodity to rebound, according totraders and nuclear experts.
Why avoid commodities? Speculation has changed the nature of some markets
Source: Bloomberg.
Investing in Commodities: Curve AsymmetriesPercentages of time in backwardation vs. contango
over past 10 years
Sources: UBS, Bloomberg.
Investing in commodities: Index weightingsComposite Indices -
Target Weights Per Sector as of February 2009
Sources: UBS, Bloomberg.
Investing in commodities: Weights/selection impact return
Oil in Contango
= indices with a heavy front month crude
investment lose
Oil in backwardation or heavy focus on a strong performer =
strong performanceSource:Bloomberg.
Investing in commodities: Most investors only use spot
Fixed Income Investors
Invest across
the yield curve Not just 1-month T bills
Commodity Index Investors
Generally limited to “1-month T-bills”
(i.e. short dated futures)
Partially responsible for disappointing returns
(negative roll yield)
Commodities have a forward curve just like bonds –
yet most investors ignore this
Source: Bloomberg.
Investing in commodities: Average tenorsInvesting across the curve enhances returns and lowers volatility
Source: Bloomberg.
Roll mechanism in detail
Sources: UBS, Bloomberg.
Mark Cutis slides
Abu Dhabi Investment CouncilMarch 22, 2009
Update on agricultural commodities:
The Time is now
Investing in agriculture: Why now?Agricultural complex: downward price correction almost over
there has been a brutal deleveraging since mid 2008
Soft commodities and grains will soon rebound- grain stocks are at historic lows
Quantitative easing will spill over to all commodities
If you believe that inflation could become a concern, then invest in commodities.
Pricing of commodities close to or below production costs so favorable entry level
EM world continues to improve their diet hence eating more protein;
EM world contributing more to global growth.
However if you believe that we are in the long ‘great depression’ world, then do not invest in commodities.
but of course, no sense in investing in stocks either; stick to government bonds!)
Defensive posture argues for allocation to commodities: in particular agriculture.
The ” how to” for Special Situations
More importantly an allocation should be made at strategy level
Do you really expect deflation in a fiat currency environment?
Shift to fiat currency system practically eliminated the recurrent episodes of deflation of the prior two centuries.
Sources: Historical Statistics of the United States, Earliest Times to the Present: Millennial Edition, Cambridge University Press, Banc of America Securities-Merrill Lynch Commodity Research.
Agricultural commodity prices
Correction from mid-2008 highs has been severe
MLCX Merrill Lynch Agriculture index
S&P GSCI Agriculture indexSchroders
Agriculture index
Agriculture prices: big slide was over by Dec 2008
S&P GSCI Agriculture TR Index
46
Correlation to energy has been increasing over time
… due to biofuels
and demand substitution (for example polyester and cotton)
47
• Correlation between oil markets and agricultural markets has been increasing in last decade• So agricultural demand recovery cannot be far from recovery of global energy demand
Population growth decreasing, but calorie intake increasing among emerging markets
•
Rise in GDP increases calorie intake at a higher rate in EM than OECD.
•
Since EM is responsible for a higher share of income growth, global calorie intake and demand for agriculture will increase at higher rate, going forward.
Sources: National Census Survey; USDA; and ALTIMA analysis.
Fundamental drivers of future price increase:
4. Limited agricultural landArable land could still increase further in Africa and South America, but political and infrastructure costs will be high
Global agricultural acreage expanded rapidly in the 1960s and 1970s, but current increase has been limited despite extended period of high prices
Source: Bloomberg, Merrill Lynch Commodity Research Sources: Bloomberg, Merrill Lynch Commodity Research
P.S: Potential equivalent increase does not include land that has government restrictions on its cultivation
Fundamental drivers of future price increase:
5. Crops produced at a loss, given projected prices at harvest
2009/10E crop break-even costs:Prediction of losses for wheat growers
Fertilizer price declines are expected, but not enough to offset lower crop prices
More important than spot grain prices are grain prices at time of harvest. Forward grain prices now are:
Corn Z9:
$3.96Soy X9: $8.17 This means that not just wheat farming is in the red but perhaps
also soybean!Wheat
N9: $5.20 Source: GS Global ECS Research.
Fundamental drivers of future price increase:
5. Crops produced at a loss, given projected prices at harvest
• Wheat farming in the red; soybeans might be there too!
• Corn prices close to break-even prices
•Farming was lucrative in 2007, but not anymore
Marginal cost of wheat production
0123456789
2005 2006 2007 2008 2009F 2010FSeed FertilizerChemicals Fuel, lube, and electricityOther operating costs LaborMachinery and equipment LandOther allocated costs Price, marketing year
$/bushel
Marginal cost of soybean production, US
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
2005 2006 2007F 2008F 2009F 2010F Seed Fertilizer Chemicals Fuel, lube, and electricity Interest on operating capital Other operating costsLabor Machinery and equipmentLand Other allocated costsPrice, marketing year
$/bushelMarginal cost of corn production, US by planting year
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2005 2006 2007F 2008F 2009F 2010FLand Machinery and equipmentFertilizer Fuel, lube, and electricityChemicals LaborOther operating costs Other allocated costsPrice, marketing year
9. Changing weather patterns• Increase in anomalies in global climate • Severe weather patterns in US corn belt
• The US corn belt is a recipient of severe weather patterns•
Unpredictability and surge of severe weather rates will continue to put downward pressure on supply and upward pressure on prices.•
If increase in agricultural land comes from Africa and Latin America, then expect more unpredictability in demand due to lack of readiness of EM farmers for severe natural
conditions
Source: FAO Source: FAO
Fundamental drivers of future price increase:
10. Flattening of yields
0
1
2
3
4
5
6
7
1961 1966 1971 1976 1981 1986 1991 1996 2001 2006
Rice Yield in China
Corn Yield in China
Wheat yield in India
Tons
per
hec
tare
Corn and wheat yields 1961-
2007
Source: FAO
,
Sources: FAO, Merrill Lynch Commodity Research.
• There has been a decline in yield increases
•
By the 1990’s “Hectare Per Tractor”
growth has become small. The gains in productivity have been had.
•Now, marginal farmers are adding to their machinery use, but at the slowest pace ever recorded.
•In Africa and Latin America, yield growth faces political and infrastructure problems
Fundamental drivers of future price increase:
11. Credit crunch…
lack of financing available to farmers
•
Shortage of farming credit is less an issue in OECD, due to gov’t-backed agricultural credit markets. •
In contrast, the scarcity of credit is a real risk in Emerging Markets.–
Access to high input costs is cramped by non-functioning credit markets in developing countries.
–
This is more of a risk to yields than acreage, since farming land will still be utilized while less seeds, fertilizers and pesticides should be applied.
–
This will particularly hit fertilizer intensive crops, such as corn or coffee. –
Even in Brazil, a country with relatively well developed credit markets for agriculture, farming financing is drying up. Large agricultural companies, such as Bunge, Archer Daniels Midland, and Cargill, are scaling back their system of funding farmers in
return for future crops as payment.
–
The credit crunch has halted the development of food supply channels. In many African and Asian countries, 25 % of food cereals are discarded each year.
–
Also at risk are diversified, resilient ecosystems (rainfall management, inter-cropping) that sustain and increase yields longer term.
Going forward
A changing supply and demand profile •
Limitations to the amount of new cultivated land. •
Supply response from the least developed nations not enough: needed investment in education, training and extension services.
•
The epicenter of global agriculture: shift from the OECD to developing countries. •
By 2017, developing countries are expected to dominate production and consumption of most commodities, with the exception of coarse grains, cheese, and skimmed milk powder⇒ changing profile of the marginal supplier. ⇒more vulnerability to severe weather fluctuations: new producers less able to deal with these changes
•
The technology (increasing yields) argument: Q: increasing yields in EM putting downward pressure on prices?A: Productivity gains in manufacturing (which increases food demand) outweighing productivity gains in agriculture (which increases food supply)…
Agriculture: Preparing for a price recovery•
Despite a comprehensive slowdown, and increased correlation to energy, agricultural prices are less vulnerable compared to other parts of the commodity complex.
•
And the commodities overall are
at utilization levels that will usher in a swift price recovery
as demand recovers.
•
In addition, there are financial and economic challenges to acreage expansion. Farmers are having a hard time getting banks to lend
to
them.•
Long-
term fundamentals mean that demand will rise due to changing demographics, economic growth in emerging markets, and urbanization.
•
In the medium term, upward pressure on prices due to economic recovery, biofuel
mandates, supply destruction, unpredictable weather patterns, and historically low stocks.
•
Despite correlation and substitution between crops, there are some ‘defensive’
members , including wheat that are less affected by the global slowdown. (wheat is less exposed to slowdown when compared to soybeans for example)
•
A protracted slower growth in emerging markets may still push prices a bit lower in the very short term;
–
Don’t bet against demographics•
The persistent fundamental drivers of demand, supply destruction, and low stocks will mean that agriculture is expected to have an early and sustained price recovery.
Crops have different income elasticity and demand drivers
Wheat long term bullish due to historic demand elasticity
Income elasticity varies by crop; wheat relatively inelastic (1976-2006)
Cheaper wheat might mean an opportunity for a price rally in medium term
Source: ML Commodity Research.
High crop price volatility partly due to substitution between crops
Substitution by both consumers and farmers
• Crop prices move together in large part due to substitution on both demand and supply sides.• Therefore ‘selecting crops’
strategy has its limits in the medium term:
Source: ML Commodity Research.
US farmland
5000
6000
7000
8000
9000
10000
11000
2004 2005 2006 2007 2008
$/ha
Land pricesUK Farmland price
6000
7000
8000
9000
10000
11000
12000
13000
14000
2004
Q3
2004
Q4
2005
Q1
2005
Q2
2005
Q3
2005
Q4
2006
Q1
2006
Q2
2006
2H
2007
1H
2007
2H
2008
1H
2008
2H
£/ha
US
agricultural land prices
UK agricultural land prices
0 2,500 5,000 7,500 10,000 12,500 15,000
Russia
Bulgaria
Estonia
Romania
Hungary
Argentina
Canada
USA (East)
Finland (South)
England
N. Ireland
Denmark
Netherlands
In USD/ha:
Global agricultural land price comparison
Agriculture will continue to track energy prices
Economic slowdown and de-leveraging meant low agriculture pricesGiven the increase in correlations: corn, soybeans, wheat, and sugar prices will remain weak in very near term if you believe oil prices will stay
Sources: Merrill Lynch, BP, CIA World Factbook, Factset, IMF World Economic Outlook, Datastream, Bloomberg.
Winston Churchill speech to The Commons
on May 2, 1935
Air Parity Lost•
“When the situation was manageable it was neglected, and now that
it is thoroughly out of hand we apply too late the remedies which then might have effected a cure.
•
There is nothing new in the story. It is as old as the Sibylline
books. It falls into that long, dismal catalogue of the fruitlessness of experience and the confirmed unteachability
of mankind. •
Want of foresight, unwillingness to act when action would be simple and effective, lack of clear thinking, confusion of counsel until the emergency comes, until self-preservation strikes its jarring gong, these are the features which constitute the endless repetition of history."
Mari Kooi
slides
The monetary environment
Monetary policy
•
Monetary Base is exploding but it is mainly excess bank reserves. •
Offset by collapse in lending and velocity•
The gas pedal is on the floor but the question is whether the pedal is pulled back in time before we go over the inflation cliff
•
Depends upon whether central banks know which way to turn and when
M2 money multiplier and excess reserves
Source: Federal Reserve. M2 multiplier through March 30, 2009. Excess reserves through April 8.