David Donora, head of Commodities at Threadneedle Investments, says supply and demand factors point to stability in prices.
Q: Are you still positive on the oil market?
Yes, we are, because of the tightness I mentioned – there is not much spare capacity in the global oil market and the increase in demand that results from the economic growth we are forecasting should be enough to support prices. We also have ongoing geopolitical risk in areas such as Nigeria and the Middle East, which could lead to production being curtailed, and this could see the price of oil spike significantly. These factors affect Brent more than WTI and so our exposure remains skewed in favour of Brent. We expect the price dislocation between these two markets to continue at least for the rest of this year and probably into next.
Q: Is there a case for investing in mining companies rather than the commodities they produce?
Resources companies have sharply underperformed the corresponding commodities over the past couple of years and, on a pure valuation basis, they now look more appealing than they have done for a while. However, companies are facing escalating costs on projects to increase capacity and have been reluctant to initiate new projects given the uncertain macro outlook. This is making it more difficult for them to translate higher commodity prices into higher profits. Meanwhile, geopolitical risk and associated supply disruptions often boost the underlying commodity price but are more difficult for the producers. So we continue to prefer the direct commodity route, although we are underweight in base metals at present and market weight in precious metals.
Q: Finally, what are the main factors you consider in positioning the portfolio?
It is principally a bottom-up process designed to produce strong views that we can translate into active positions in the fund. We begin by analysing market fundamentals, assessing the sources and dynamics of supply and demand including inventory levels, production and logistical bottlenecks and weather-related factors. We also speak to commodity-producing companies to understand their plans, and we spend a lot of time analysing the geopolitical background, which can impact both production and demand. We need to stay on top of technological advances, such as the recent development of horizontal fracturing, which has affected supply and therefore prices in the US oil and gas markets. All of these are influences on the spot price of commodities. We then turn to the term structure of markets, because as active managers we can augment spot returns by considering the shape of the futures curve and our optimal positioning on it. Finally, we take seasonality into account and we pull all of this together into a view on the relative value between and within commodities.