ETF Trends
ETF Trends

“Time to Buy Commodities,” blared one business headline a few weeks back, above a story detailing just how far commodities have tumbled. Indeed, I see several reasons why investors may want to consider increasing their exposure to the oil markets.

While Saudi Arabia increases production, the US and China see record demand

As of this writing, the new front-month October 2015 crude oil contract is trading around $45 per barrel, having bounced strongly off of the 2009 crisis lows on news of a supply disruption in light sweet crude coming out of Nigeria.1 Over the past year, crude oil prices are down more than 60%. This slide was initially triggered by increased production quotas (or the abandonment thereof) by Saudi Arabia – viewed by many a calculated attempt to oversupply the global crude market, drive down crude oil prices and regain lost market share. Over the past five years, the Saudis have ramped up crude oil production from a low of 8.04 million barrels per day in August 2009 to a high of 10.57 million barrels per day in July 2015.2 Then, just when it looked like there was no end in sight to the sell-off in crude, the bears received a one-two punch.

The first blow came out of China, which announced consolidation measures among state-owned companies. This action hinted at an impending injection of economic stimulus that could spur further energy demand. China also took advantage of lower crude oil prices to restock reserves in July and simultaneously removed crude oil import restrictions for smaller, private Chinese refineries. The resulting increase in crude oil demand — China imported a record amount of crude oil in July — surprised many market participants, who ascribed recent weakness in commodity prices to a fear of falling demand from China.

But the surprises didn’t only come from China. July saw record crude oil demand in the United States as well, where lower crude prices have spurred increased domestic consumption.

An unusual pattern is emerging in oil markets

Despite this backdrop of record crude oil demand by the world’s top two consumers – the US and China – the market is seeing crude dipping to levels not seen since the height of the 2009 financial crisis in response to equity market turmoil.

Somewhat surprising, however, is the relative strength in the longer end of the benchmark West Texas Intermediate crude oil futures curve. This has led to a steepening in the curve and an increase in what traders call “contango” – a market exhibiting higher prices at future dates and lower prices in the near term. Why is a steepening oil futures curve unusual? Typically, a market concerned with future economic growth and demand for commodities will flatten an upward-sloping curve in contango. That is to say, longer-dated crude contracts will sell off with diminished expectations for future economic growth.

In late August, however, the market seemed to embrace the notion that growth in demand will clear the overhang in global crude oil supplies. That means that traders are bidding up the back-month futures contracts more than the front-month contracts – steepening the upward-sloping curve. You can see this dynamic at work in the following graphic, with the orange line depicting recent price action.

The crude oil futures curve steepens

Crude oil prices respond to market dynamics

In the end, the crude oil market has been dominated by fundamentals over the past year — first with the Saudis on the supply side and, most recently, China and the US on the demand side.

Crude oil production in the US has been leveling off of late and the Saudis, who are rumored to be approaching their maximum achievable output, have already begun to cut output. Given negative sentiment on crude oil and other commodities, improving global demand and the less bearish production profile in the US and Saudi Arabia, I believe that many crude oil-related shares are attractively valued.

Investors looking to go long in crude at today’s prices may wish to consider the PowerShares DB Oil Fund (DBO) – designed for those who want a cost-effective* and convenient way to invest in commodity futures. We believe DBO is very well-positioned to take advantage of potentially improving crude oil fundamentals over the coming months and years.

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