2007 Was Commodities' Banner Year, More Reasons to Be Bullish for 2008

It was the best of times, it was … well, it was pretty much just the best of times.

2007 was a banner year for commodities, as the broad-based commodity indexes rose strongly across the board.

Of the major commodity indexes, the Goldman Sachs Commodity Index (GSG), delivered the best return, rising 36% between January 3, 2006 and January 2, 2007. The GSCI’s heavy oil weighting helped, as the combination of strong crude oil prices and a backwardated oil futures market boosted returns.

With its lofty return, the GSCI outpaced all major equity asset classes, including U.S. stocks (up 3%), international developed market stocks (up 7%) and emerging markets stocks (up 30%). It also outperformed hedge funds (up 10-15%), European stocks, bonds, the Euro and more. To beat the GSCI, you pretty much had to concentrate your money in the “right country” (like Brazil or China, up 70% and 67% respectively) or the right subsegment of the market (like steel, up 80%+).

Illustrating the importance of choosing the right commodity index, the DJ-AIG Commodity Index (JJA) delivered just an 18% gain, thanks to a low weight in outperforming crude oil and a relatively high weight in poor-performing natural gas.

As always, buyer beware.

Subsegment Performance

Drilling down into subsector performance, the best place to be in 2007 was on the farm. It’s too early to have full-year data in hand for all the subsegment indexes, but looking at one-year performance through December 4, 2007, in the table below, you can see there was huge variability in the different parts of the market. Within the DJ-AIG subsegments, agriculture led all major sectors with a 24.0% return, while Industrial Metals fell 12.4%, as a weak second half of the year took its toll. Still, we shouldn’t cry for Industrial Metals investors: Over the past three and five years, they have done quite well indeed.

For the record, Petroleum (not shown) did even better than Ags, posting a 30%+ return; the energy sector of the DJ-AIG was pulled down by natural gas’ poor 1-year performance.

Commodity Sector Performance – December 4 through December 4 (Years Ending 2007) Index 1-Yr 3-Yr Cumulative 5-Yr Cumulative DJ-AIGCI Agriculture 24.0% 42.9% 36.7% DJ-AIG Precious Metals 16.7% 72.1% 157.1% DJ-AIG Energy 2.8% -8.6% 70.0% DJ-AIG Industrial Metals -12.4% 125.0% 256.3%

The data in the table above is from ETF Securities, which has a detailed, commodity-by-commodity analysis of the commodities market for 2007 available in PDF format here.

Looking Ahead To 2008

What will 2008 bring? There are as many predictions as there are market prognosticators. Generally speaking, investors remain bullish on commodities, and with oil hitting $100/barrel yesterday, it’s not hard to see why.

Barclays Capital takes a commodity-by-commodity look at 2008 in its new Global Outlook booklet. Although the document is not available online, we can summarize the findings here.

Generally speaking, Barclays is bullish on the commodities space. It expects commodities pricing to remain robust overall, with energy prices strong and base metals suffering somewhat depending on the extent of the global economic slowdown in 2008.

Agriculture

In the Agricultural patch, Barclays is positive almost across the board, although it expects corn, soybeans and cotton to perform the best; the outlook for wheat is less certain.
Corn stocks, according to Barclays, are at the lowest levels in 33 years, and demand remains high due to ethanol and other factors. Moreover, farmers may shift more acreage into wheat in 2008, restricting supply growth for the corn market.

Barclays reserves its most bullish comments for cotton, noting that demand is skyrocketing thanks to China’s fast-growing textile industry, while supply is expected to shrink slightly in 2008.

Energy

Turning to energy, Barclays expects oil prices to rise by at least 10% this year toward the $100/barrel mark. The major factor in Barclays’ eyes is supply, with little-to-no supply growth throughout the market—including zero new supply in now-OPEC countries. It expects a “prolonged tendency towards backwardation” in the oil markets, and expects Iran to dominate security discussions in the energy patch.

Precious Metals

Barclays sees gold prices as “firmly within a medium-term uptrend,” and says that continued concerns over inflation and dollar-weakness should more than compensate for increased central bank sales to tip the balance in favor of gold.

Industrial Metals

Industrial metals are the most exposed to any potential economic slowdown, which combined with rising inventory levels to push prices down in Q4 2007. But Barclays expects strong emerging markets growth to more than offset U.S. weakness in 2008, provided there is no credit market contagion. It notes that Chinese consumption accounted for “85-170% of global growth in base metals consumption” in 2007, with the strongest growth in demand for lead.
In the end, Barclays is bullish for most metals in 2008. It forecasts higher prices for copper, lead and tin; mixed returns for aluminum and nickel; and continued weakness in zinc.

Comments

[sbenard]

I'd like to see someone write an article about the phenomena that commodity prices usually drop on weak demand during a recession. I trade commodities, but worry that demand will drop and the bull market will acquiesce to that weaker demand.