Commodities exchange traded funds could be stuck in an extended downtrend as a so called negative feedback loop of increased production and high liquidity keep pressure on prices.
The broad commodities market has been trending lower. Year-to-date, the GreenHaven Continuous Commodity Index Fund (NYSEArca: GCC) dipped 6.7%, PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC) fell 7.5%, iPath Dow Jones-UBS Commodity Index Total Return ETN (NYSEArca: DJP) declined 7.4% and iShares GSCI Commodity-Indexed Trust (NYSEArca: GSG) dropped 8.3%.
“Commodity markets still have access to far too much capital relative to future demand and a declining cost structure,” according to Goldman Sachs analysts, reports Ben Sharples for Bloomberg. “Long-term surpluses in most commodity markets require prices to remain lower for longer to balance both the near-term physical supply and demand, but more importantly, the longer-term supply and demand for capital to fund future investments.”
Goldman believes the commodities market may be stuck in a “negative feedback loop” where lower prices are bolstering the U.S. dollar and lowering production costs for countries with depreciating currencies. The bank argues that it raises the prospects of higher interest rates and reduction in emerging market debt, which could also lead to lower commodities demand, lower resource prices and further strengthening the greenback.
To get out of this cycle, commodity prices would have to plunge to a point where it forces low-cost producers to cut supply. Consequently, Goldman projects that the commodity slump could last five to 10 years before any meaningful changes are made.
Energy commodities are especially vulernable to the cycle. Specifically, the recent recovery that brought oil prices back up to $60 per barrel has triggered greater U.S. drilling – U.S. drillers added rigs last week for the first time since December. Additionally, the rebound in crude oil allowed low-cost producers to raise current and future output – the Organization of Petroleum Exporting Countries raised output to its highest level since August 2012.
The broad commodity ETFs are also susceptible to changes in oil prices as the funds are heavily weighted toward fossil fuel-related commodities. For instance, GCC includes a 18% tilt toward energy equally divided among natural gas, crude oil and heating oil. DBC includes heating oil 12.4%, light crude 12.4%, natural gas 5.5% and RBOB gasoline 12.4%. DJP holds WTI crude 9.6%, Brent crude 9.1% and natural gas 8.0%. [Pick and Choose Commodity Exposure with ETFs]
For more information on the commodities market, visit our Commodity ETFs category.
Max Chen contributed to this article.