Pimco Calls Worst of Commodity Crunch Over With Oil Seen Gaining

  • Collapse in energy, metals prices is `largely behind us'
  • Investor sees oil `baseline' near $60 a barrel in 12 months

The worst of the collapse in commodities prices is probably over, with oil poised to gain over the next 12 months, according to Pacific Investment Management Co. Just don’t expect a major rebound.

Producers are shelving projects and scaling back output from Arctic oilfields to Indian aluminum mills amid the weakest returns from raw materials since 1999. While the response may help draw a line under the rout, prices are set to remain “lower for longer” because of excess inventories, according to the firm that manages $15 billion in commodity assets.

"The declines in commodity prices are largely behind us," executive vice presidents Greg Sharenow and Nic Johnson said in an e-mail. Newport Beach, California-based Pimco has about $1.52 trillion under management. "Most prices are well into the marginal cost curve across metals and oil, and that will help to put a floor under prices here.”

Oil Poised

Oil may rise to a “baseline” of about $60 a barrel in one year’s time as the impact of supply cuts becomes more evident from early 2016, according to Sharenow. U.S. crude output is down about 440,000 barrels a day from a four-decade high of 9.61 million barrels in June and the nation’s drillers have sidelined more than half of the country’s rigs in the last year.

Benchmark crude in London and New York tumbled to six-year lows in August and weaker prices are having a “significant impact on forward production growth,” said Sharenow. Factor in natural decline rates and it means the oil market can re-balance supply and demand faster than other sectors like steel or aluminum, he said. West Texas Intermediate was at $49.63 a barrel on Friday while Brent was at $52.65.

Pimco says oil production cuts to become more evident in 2016
Pimco says oil production cuts to become more evident in 2016

Producers are benefiting from oil’s best week since August. A Bloomberg Intelligence index of North American exploration and production companies is up 34 percent since touching a six-year low last month.

Platinum Attractive

Gold prices are “broadly fair at the moment,” said Johnson. “If real yields move lower or the Fed delays rate hikes beyond market expectations, we would expect gold to do well.” The probability that the Federal Reserve will increase rates this year has dropped to 39 percent, from as high as 77 percent in August, according to futures data compiled by Bloomberg. Spot bullion has rebounded about 7 percent after sliding to a five-year low in July and was at $1,156.53 an ounce Friday.

Silver and platinum, which have declined on weaker industrial demand and slower emerging-market growth, are both attractive at current prices and trading at multi-year lows relative to gold, Johnson said. Platinum this month touched the weakest in almost seven years, while silver fell in August to its lowest since 2009.

Gold trading above platinum, ratio widened to record high this month
Gold trading above platinum, ratio widened to record high this month

Copper at Risk

Even as copper producers curb output, the metal remains most at risk from a further slowdown in China’s growth, according to Johnson. China, which accounted for almost half of demand for the metal in 2014, may lower its economic growth target to 6.5 percent in 2016 from 7 percent this year, according to Yang Zhao, the chief China economist at Nomura Holdings Inc. The metal was at $5,295 a metric ton on the London Metal Exchange, down about 15 percent this year.

“The rest of the base metals are much further along in their supply-side adjustments,” said Johnson.

How copper prices respond when market falls into deficit
How copper prices respond when market falls into deficit

Wheat Watch

Forecasters predict the current El Nino weather pattern may become one of the strongest ever recorded and Pimco is “closely watching wheat,” particularly given the prospect of a smaller crop in Australia. Farmers in the world’s fifth-biggest exporter typically begin harvesting from October. Wheat futures in Chicago fell to the weakest in about five years in May and have since rebounded to $5.0925 a bushel.

Otherwise, current agricultural prices look sustainable for a long time, absent weather-induced supply shocks, while soybeans are “starting to look a bit cheap relative to other grains,” Johnson said.

Ratio fell in October to lowest since 2013
Ratio fell in October to lowest since 2013
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