Investment Insights: Energy’s Shifting Return Drivers
Summary
• Changes in the global oil supply dynamic may likely continue to weigh on the drivers for oil and energy prices.
• The traditional negative relationship between the US Dollar and oil prices has broken down and is currently positive.
• Roll and collateral yields may see further prominence.
Read more here.
Maxwell Gold
Director
–Investment Strategy
1
Past performance is no guarantee of future results.
Investment Insights
May
201
7
Energy’s
Shifting Return Drivers
Summary
•
Changes in the global oil supply dynamic may likely continue
to weigh on the drivers for oil and energy prices
.
•
The traditional negative relationship between the US Dollar
and oil prices has broken down and is currently positive.
•
Roll
and collateral yields
may
see further prominence.
The
expected
global economic backdrop
remains
broadly
supportive for the
energy
sector
in coming years
. Demand for oil
remains robust driven by f
urther
recovery of global growth
accompanied
with building inflationary pressures
, while efforts to
reduce the global supply glut are underway
. These
changes in
supply side fundam
entals are beginning to unravel and impact
some of
the
traditional drivers of energy returns
including the US
dollar
(USD)
, interest rates, and curve structure.
Fundamentals in Focus
On May 25
th
the Organization of the Petroleum Exporting
Countries (OPEC) agreed to extend production cuts that it initially
implemented in November 2016. This 9
-month extension, ending
March 2018
, is a direct response of the changing landscape of
global oil supply dynamics.
Since enacting these cuts, OPEC production has dropped from 34
to 32 million barrels per day.
OPEC’s strategy, however, has
resulted in a loss of market share without the comm
ensurate rise in
price.
The rise of North American shale oil and gas production in
recent years has made this region the current swing producer to the
global oil market
- a trend likely to persist (see Exhibit 1).
Exhibit 1
: The role of US
production and s
upply continues
to
grow in importance for global
energy
market
s.
Changing Dollar Dynamic
The
rule of thumb known to many investors
is that the US dollar
has an inverse relationship
with oil and energy prices
. This negative
relationship was most prominent from 2003 to 2014 (see Exhibit
2). During this period the US current account deficit rose driven by
oil imports which boosted oil prices. Concurrently, this led to a
large
build
-up of current account surpluse
s (held in USD) in oil
exporting economies increasing supply of USD reducing its value
Exhibit 2
: Oil’s inverse relationship to the dollar was most
prominent from 2003 through 2014
While oil and USD have a -
0.11 correlation since 1983, this
traditional
relationship has broken down in recent years and is
currently positive (see Exhibit 3).
This low
and positive correlation
with USD may likely continue with the dollar’s significance as a
driver of oil and energy prices becoming more muted in markets.
Exhibi
t 3
: Oil and USD
correlation currently positive
.
4
5
6
7
8
9
10
28
29
30
31
32
33
34
35
20 11
20 12
20 13
20 14
20 15
20 16
20 17
Barrels per day (millions)
Barrels per day (millions)
US Pro ductio n (rhs)
OPEC Production (lhs)
S o u r ce: Blo om ber g, ET F S ecurit ie s. Da t a fr om 01 /01 /1 1 t o 0 4/3 0/1 7 .
0
20
40
60
80
100
120
140
70
80
90
100
1 10
120
130
140
150
160
1 70
1983
1985
1987
1989
199 1
199 3
199 5
199 7
199 9
20 01
20 03
20 05
20 07
20 09
20 11
20 13
20 15
20 17
US$/barrel
Index Level
US Dollar Index (lhs)
Oil Price (rhs)
Sou r c e: Bl oom berg, ET F Sec u riti es. Da ta fr om 1 2/31/90
t o 4 /3 0/1 7.
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
1984
1986
1988
199 0
199 2
199 4
199 6
199 8
20 00
20 02
20 04
20 06
20 08
20 10
20 12
20 14
20 16
5 2 Wekk Co rrelation
Dollar/Oil
Dollar/Bloomberg Energy I ndex
Sou r c e: Bl oom berg, ET F Sec u riti es. Da ta fr om 1 2/31/90
t o 4 /3 0/1 7.
2
Past performance is no guarantee of future results.
As the US has ramped up its domestic production
since 2010, this
has increased its
energy self
-sufficiency. This changing supply
dynamic has simultaneously aligned US growth much closer to
global e
nergy market
s, leading the USD to behave more like
traditional commodity currencies. Unlike recent decades, a
s the
US’s role as the global swing producer continues, m
arkets will likely
see oil markets continue to be driven more by fundamentals
A r
eturn
to
backwardation
?
Among the three components of total return when investing in
futures contracts (price return, roll yield, and collateral yield), the
roll yield for the energy sector has been a continuous perfor
mance
drag over the last decade (see Exhibit
4).
Exhibit 4
: Drag on performance
.
Oil futures markets are most often in a state of contango, whereby
the futures price is greater than the spot price. When inventors roll
into new contracts at expiration there is an implied cost of buying a
more expensive contract, resulting in a negative roll yield
component to total return.
Exhibit 5
: Contango in oil markets continues to fall.
Since oil prices bottomed out in early 2016, the degree of contango
in futures markets has been reduced. Year to date, the
oil market
has become even closer to backwardation (see Exhibit 5). If global
supply is reduced at a higher rate and oil inventories continue to
experience drawdowns, this may
push the market towards
backwardation thereby bringing roll yield back into focus as a key
contributor for oil and energy total returns.
Another component for total returns that has diminished over the
last decade is collateral yield. In the current low i
nterest rate, the
yield garnered from holding collateral against futures contracts has
been minimal. This may see a bit of a reprieve against expectations
of further tightening by the Federal Reserve this
year
. Additionally
nominal interest rates are a key
driver for energy commodity prices
and a rising rate environment may be met with higher prices. Crude
oil and gasoline perform positively on average in rising rate
environments while natural gas tends to benefit from falling market
interest rates (see Exh
ibit 6).
Exhibit 6
: Rising rates may boost oil and energy prices
.
Source:
Bloomberg, ETF Securities. Data from 01/31/91 to 04/30/17. Energy sector is
represented by the Bloomberg Energy Spot Subindex.
Outlook: Crude Oil
OPEC’s decision to extend its pr
oduction cuts through March 2018
was met with disappointment
in markets. While t
his is a positive
sign for the global crude market which continues to rebalance from
a multi
-year supply glut, expectations of continued US productions
will remain in focus
. There have been encouraging signs in recent
weeks of US inventory drawdowns which if sustained could support
current price levels.
Additionally,
OPEC has had a p
oor
track record
in keeping compliance
to its stated quotas
. L
ack of follow through
on this exte
nded deal by OPEC members may
weigh negatively on
prices.
With co
ntinued tightening fundamentals and reduced
investor sentiment
(see Exhibit 7)
, w
e expect prices to range from
$40
-55/barrel this year.
Exhibit 7
: Oil positioning has unwound recent highs
.
-600
-400
-20 0
0
20 0
400
600
800
1,0 00
1,2 00
1,4 00
199 1
199 3
199 5
199 7
199 9
20 01
20 03
20 05
20 07
20 09
20 11
20 13
20 15
20 17
Index Price Level
Collateral
Spot P rice
Roll Yi eld
Bloomberg En ergy Total Return In dex
Sou r c e: Bl oom berg, ET F Sec u riti es. Da ta fr om 1 2/31/90
t o 4 /3 0/1 7.
($3)
($2)
($1)
$0
$1
$2
$3
$25
$30
$35
$40
$45
$50
$55
$60
$65
J a n -1 5
Apr-15
J u l-1 5
Oct -15
J a n -1 6
Apr-16
J u l-1 6
Oct -16
J a n -1 7
Apr-17
Contango/Backwardation Level
Price/barrel
Contago - WT I Contract (rhs)
Pr ice - WT I C ontr ac t (lhs)
S ou r ce: Bloomber g,
ETF Securities. Data from 01/01/1 5 to 05/26/17. WTI = West Texas
In t ermediate.
Monthly Pr ice Retu r ns
(01 /3 1 /91 to 4/3 0/1 7 )
Rising
Interest
Rates
Falling
Interest
Rates
Av erage
Energy Sector
0.7 %
0.7 %
0.7 %
WTI Cr u d e
1.4%
-0.1 %
0.7 %
Brent Crude
1.6%
-0.3%
0.7 %
Gaso line
3.5%
-2.5 %
0.6%
Natural Gas
-1 .2%
4.0%
1.4%
Heating Oil
1.0%
0.4%
0.7 %
(300 ,00 0)
(200 ,00 0)
(1 00, 000 )
-
100 ,00 0
200, 000
300,0 00
400, 000
50 0,0 00
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Ma n a ged Mon ey WTI Oil Fu t ures
Con t r ac ts
Long
Short
Net
Sou r c e:
Bl oom berg, ET F Sec u riti es. Chart dat a from 1 /1 /08 t o 5 /1 6/17.
ETF Securities (US
) L
LC
405
Lexington Avenue
New York
NY 10174
United
States
t +1 844
– ETFS
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Important Risks
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of
future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would
be profitable in the future. This information is n
ot a recommendation to buy or sell. Past performance does not guarantee future results.
The ETFS Silver Trust, ETFS Gold Trust, ETFS Platinum Trust, ETFS Palladium Trust and Precious Metals Basket Trust are not
investment companies registered under the In
vestment Company Act of 1940 or a commodity pool for purposes of the
Commodity Exchange Act. Shares of the Trusts are not subject to the same regulatory requirements as mutual funds. These
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a single commodity generally experience greater volatility.
Commodities generally are volatile and are not suitable for all investors
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greater volatility. Please refer to the prospectus for complet
e information regarding all risks associated with the Trusts. Shares in the Trusts are not
FDIC insured and may lose value and have no bank guarantee.
The value of the Shares relates directly to the value of the precious metal held by the Trust and fluctua
tions in the price could materially adversely
affect investment in the Shares. Several factors may affect the price of precious metals, including:
•
A change in economic conditions, such as a recession, can adversely affect the price of the precious metal held by the Trust. Some metals
are used in a wide range of industrial applications, and an economic downturn could have a negative impact on its demand and,
consequently, its price and the price of the Shares;
•
Investors’ expectations with respect to the rate
of inflation;
•
Currency exchange rates;
•
interest rates;
•
Investment and trading activities of hedge funds and commodity funds; and
•
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precious metal held by the trust or producing companies, it could cause a decline in world precious metal prices, adversely a
ffecting the
price of the Shares. Should there be an increase in the level of hedge activity of the precious metal
held by the Trusts or producing
companies, it could cause a decline in world precious metal prices, adversely affecting the price of the shares.
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could cause a decline in prices,
negatively impacting the price of the shares. There is a risk that part or all of the Trusts’ physical precious metal could b
e lost, damaged or stolen.
Failure by the Custodian or Sub
-Custodian to exercise due care in the safekeeping of the precious metal held by the Trusts could result in a loss to
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nsurance or any
insurance with respect to the precious metals held by the custodian on behalf of the Trust. Consequently, a loss may be suffered with respect to the
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Diversification does not eliminate the risk of experiencing investment losses.
Commodities generally are volatile and are not suitable for all investors.
Please refer to the prospectus for complete information regarding all risks associated with the Trust.
Investors buy and sell shares on a secondary market (i.e., not directly
from Trusts). Only market makers or “authorized
participants” may trade directly with the Trusts, typically in blocks of 50k to 100k shares
.
The Bloomberg Energy Index is a commodity group subindex composed of futures contra
cts on crude oil, heating oil,
unleaded gasoline and natural gas
.
Correlation is a measure of fluctuation between two variables. The Organization of Petroleum Exporting Countries (OPEC) is a group consisting of 12 of the
world's major oil
-exporting nations. OPEC was founded in 1960 to c
oordinate the petroleum policies of its members, and to provide member states with
technical and economic aid.
Contango is a situation where the futures price (or forward price) of a commodity is higher than the spot price.
The opposite
market condition to
contango is known as backwardation. "A market is 'in backwardation' when the futures price is below the spot price for a part
icular
commodity
. West Texas Intermediate (WTI) crude oil is the underlying commodity of the New York Mercantile E
xchange's oil fu
tures contracts
. The spot
price is the current market price at which an asset is bought or sold for immediate payment and delivery. It is differentiate
d from the forward price or the
futures price, which are prices at which an asset can be bought or sold for delivery in the future.
The roll yield is the yield that a futures investor captures as
their long position in a futures contract converges to the spot price; in a backwardated futures market the price rolls up to
the spot price, so the roll yield is
positive, whereas when the market is in contango the price rolls down to the spot price, so the roll yield is negative.
Commodities generally are volatile and are not suitable for all investors. This material must be accompanied or preceded by
the prospect
us. Carefully consider each Trust’s investment objectives, risk factors, and fees and expenses before investing.
Please
click here
to view the prospectus.
ALPS Distributors, Inc. is the ma
rketing agent for ETFS Silver Trust, ETFS Gold Trust, ETFS Platinum Trust, ETFS Palladium
Trust and ETFS Precious Metals Basket Trust.
Maxwell Gold is a registered representative of ALPS Distributors, Inc.
ETF001163 05/31/18
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