A recovery in resources

Following a tumultuous few years, there has been a recent recovery in key commodities such as oil and iron ore, however the balance of risks remains to the downside. The recent resurgence of crude oil prices has been driven by optimism that the global oil glut is being addressed by key producing countries. In March, oil prices continued their climb as the US oil industry showed ongoing signs of a slowdown. Hopes for an agreement on a collective production freeze from the Organization of the Petroleum Exporting Countries (OPEC) further fuelled oil prices to above US$40 a barrel, which seemingly signalled a recovery for oil from the 12-year low seen at the beginning of the year. 

Following the rebound since January, iron ore has also remained strong – both surprising and puzzling many investors with its sudden surge. Iron ore prices rallied significantly in March with the announcement of pro-growth policies in China, with some suggesting speculative trading in commodities futures was potentially overheating the price. Following this sharp lift, there have been a growing number of marginal iron ore companies going back into production, which should contribute to an increased production and export of iron ore if the price holds.

So have we have seen the bottom of the collapse in commodity prices?

The overarching theme in the fall has been the issue of supply outpacing demand. While there is increased optimism as to the potential for future production cuts, the recent resurgence does not seem to be supported by key fundamentals.

An imminent OPEC meeting scheduled for April 17 will discuss a production freeze to address the ongoing oversupply that has plagued oil prices since June 2014. Considering the conflicting goals and incentives for the participating countries, there is increasing doubt that an agreement will be reached however. In particular, Saudi Arabia will not consider any production freeze without Iran’s participation, yet Iran has ruled out a freeze until its production recovers to pre-sanction levels. The concerns over this meeting reflect the recent slide in oil prices with investor caution predicted till post-meeting.

For iron ore, analysts suggest seasonal trends explain the sudden price boost. Traders tend to buy iron ore in anticipation of higher demand from China’s steel mills during construction season, which generally starts in March. Based on this assumption, the sustainability of current iron ore prices could be debated due to the global oversupply of steel and its dependence on China’s construction and heavy industry, which has slowed down considerably.

What is the outlook for commodities and prices? 

Iron ore’s demand continues to be strongly underpinned by growth in the emerging markets. As such, it is likely to face some volatility at least for the short-term as key countries such as China continue to face economic headwinds.

In regards to oil, betting on the movement of prices has repeatedly proved costly for investors. As an industry, oil has gone through cycles of supposed stability followed by a seemingly unpredictable boom or bust. Paired with the fundamentals of supply versus demand, the reason for oil’s volatility can also be attributed in its broadest sense to the almost duopolistic nature of the oil market.

On one side is the vast number of producers aggressively competing for the cheapest oil price; on the other is OPEC, acting as a cartel of the world’s major producers and exporters of crude oil. Historically, oil tends to go through a cycle of relative stability, followed by either a geopolitical event, which causes the price to soar, or the increased competition weakening OPEC’s control on the oil market, which causes prices to fall.

Furthermore, alternative energy sources such as solar are proving increasingly economically viable and could further accelerate the innovations in potentially disruptive technology such as electric vehicles. While it is unlikely for these factors to have an immediate effect, it could be an added pressure for oil prices in the future.

What does this mean for investment opportunities right now?

In light of the ongoing subdued economic conditions, the short-term resurgence of oil and iron ore may have tempted some to bet on the rebound of faltering commodities or even attempted to lock in short-term gains by taking advantage of the volatility. However, for investors looking for long-term investment strategies, there remains a level of uncertainty, which should be considered before investing in these assets. For those looking for sustainable growth over the long-term, diversification is crucial to minimise concentration risk and capture different growth opportunities across a broad range of assets classes.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Lyle Meaney

Managing Director, Wealth Advice

In his primary role as Managing Director, Wealth Advice, Lyle ensures all Investment Advisers and Analysts deliver the highest level of proactive service and advice in line with Dixon Advisory’s Investment Committee’s views on market conditions. All Investment Advisory clients have a dedicated Investment Adviser, who works closely with Dixon Advisory’s Superannuation Specialists, Financial Advisers, Estate Planners and Property Investment Specialists to deliver the best possible financial outcome. 

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