A pension fund that invests more than 100 billion euros in bonds with negative interest rates has left raw material investments altogether this year. The fund lost EUR 4 billion this year on crude oil futures contracts. That is EUR 4 billion that is no longer being made up. Goodbye is final. In itself, it is positive that this pension fund realises that commodities cannot be a structural part of a portfolio.
Investing is harvesting risk premiums. At the beginning of this century, there was much discussion about the added value of commodities in an investment portfolio. There is no risk premium for commodities. Today’s oil price may be equal to the oil price in ten years’ time. The investor does not receive a dividend or coupon but has to pay for storage, insurance, etc. According to one of Keynes’ theories, market parties want to take over the risk from commodity producers, but require a risk premium to do so. Keynes’ main focus was on those commodity producers who did not want to or could not take this risk, but nowadays just as many buyers are also covering themselves against fluctuating commodity prices. Empirically, there is also little evidence of the existence of a structural risk premium. Unfortunately, at the beginning of this century, enough scientists were hired by the sellers of commodity investments who claimed the opposite. Due to the low or even negative correlation with other investments, the added value of investing in commodities is said to be high. By the way, this argument is present in almost every presentation of an investment bank trying to sell something new. Apparently, it still works.
What always helps with a pitch are rising prices. The rising phase of the commodity supercycle is a good time to sell investments in commodities. Commodity supercycles are more common, usually around wars. After all, they cause major shifts in supply and demand. This century was the starting point for China’s accession to the World Trade Organisation in 2001. In addition, investors have ensured that the peak of this commodity supercycle was somewhat higher than in previous cycles, with side-effects such as the Arab Spring and food riots in Mexico. Just before 2001, commodity prices were at an all-time low, resulting in hardly any more investment. That was the start of a pig cycle. In the case of raw materials, it is also extremely long. There are seven to ten years between the investment decision and the production of a mine or an oil field. The time to say goodbye to raw materials was 21 May 2014. Russia signed a 30-year contract with China for the sale of Russian gas. The price agreed between the two countries was less than half the market price. When the marginal buyer (China) and the marginal seller (Russia) agree on a new price, the market has no choice but to follow. At the beginning of 2015, the oil price had more than halved.
The best remedy against a low oil price is a low oil price. After the low oil price in 2015 and 2016, investments were reduced, but the cost flexibility in the oil industry was remarkable. Shale oil and gas could also be produced at much lower costs. The Corona crisis has a much greater impact on investments. This is because the energy transition is accelerating. Incidentally, this necessary acceleration is not possible without the cash flows, knowledge of large projects and a large number of engineers in the oil industry, but it is an illusion to think that we will soon be able to do without fossil fuels. However, the energy transition and the Corona crisis are causing insufficient investment. The pig cycle is repeating itself, and it is likely that higher environmental requirements this time will result in much higher cost prices for many raw materials. Moreover, world consumption will double in the next ten years due to the large emerging middle class in Asia, boosted in part by the RCEP trade deal, which may be even bigger than China’s accession to the World Trade Organisation. On top of that comes the central banks’ fast-moving money press. There are those who believe that inflation will rise in the coming years. This is not good for bondholders with negative interest rates, but rising inflation without rising oil prices is hard to imagine. The concept of a fixed-value pension seems to have been abandoned once and for all.
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