It is difficult to predict how long this glut will last. However, It may be longer than expected if China decides to use some oil from its (unkown) strategic petroleum reserve as prices rise, and its devalued yuan makes it more expensive to import the oil.
To add to the turmoil, on average when oil is down, it drops 6.9% in a negative month. Historically, gas falls about the same amount, losing 7.0% in a negative oil month. This time unleaded gasoline has held its value relatively well, only dropping about 1/4 of the drop in oil, reducing the benefit to consumers.
From processing issues to labor costs, despite commodity drops, prices seem to be rising for consumers. Check out announcements from: Starbucks about raising prices despite a near 25% drop in coffee this year; the USDA announced rising beef and pork prices despite S&P GSCI Feeder Cattle, Live Cattle and Lean Hogs losing 8.2%, 12.1% and 22.6%, respectively; some are even reporting bread price increases despite a drop of 14.5% and 21.4% in Chicago and Kansas Wheat. At least chocolate prices are increasing with a the rise in the cocoa commodity price – that is up 5.6% year-to-date. Maybe a little extra serotonin is helping the demand in this otherwise stressful market.
To end this on a sweeter note, many index innovations have been developed to better manage rolling costs from contango. The chart below shows an annualized 10-year comparison of an enhanced rolling strategy that is relatively simple but reduced the loss by half. It also compares a more sophisticated dynamic roll that has lost less than 3%. If diversification and inflation protection are goals, a smarter rolling strategy may be useful for a potentially prolonged term structure in contango.
This article was written by Jodie Gunzberg, Global Head of Commodities at S&P Dow Jones Indices.
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