Why Oil Has Proven Resilient

by on July 8, 2013 | ETFs Mentioned:

This year has been rough for commodities. Gold is down roughly 25% in 2013, as is corn, while silver is off an astounding 35% through the end of June. But there has been one exception to this trend: energy, particularly oil.

Crude oil has proven more resilient and less volatile this year (depending on which benchmark you use, it is either up or down in the single digits) than most other commodities. There are three main factors behind this [for updates on all new ETFs, sign up for the free ETFdb newsletter]:

  1. ishares7.8Higher interest rates hit precious metals hard. While the rate regime impacts all commodities, it typically has a more pronounced impact on precious metals. The big losses in gold and silver can largely be attributed to rising real rates. To the extent rates rise in the context of a normalizing economy, the impact is likely to be more muted for energy commodities.
  2. Fears about slower Chinese growth have hit industrial metals. Losses in industrial metals – like copper, down 12% year-to-date – have been driven by fears over Chinese growth. As infrastructure building in that economy has accounted for much of the marginal demand for industrial metals, these commodities are hyper-sensitive to any perceived change in China’s appetite for raw materials. However, the demand for oil tends to be tied to the global economy, rather than a single country. In addition, a Chinese rebalancing toward consumption may actually benefit oil as more middle-income consumers purchase cars [also see Energy ETFs: Watch Your Big Oil Weight].
  3. A drop in supply. While surging North American production has captured investor imagination, what has gone largely unnoticed is the drop in supply from other sources. Heightened unrest in the Middle East and Africa, coupled with increasing sanctions against Iran, has resulted in big drops in production and exports. For example, sanctions on Iranian crude have caused exports to drop from over two million barrels per day to approximately 700,000 bpd, basically negating the surge in North American production. We’ve seen similar, though less dramatic drops from other OPEC producers, including Nigeria and Libya, both of whom are struggling with their own geopolitical issues.

With violence escalating in Syria and renewed unrest in Egypt, investors are increasingly worried about more supply disruptions, a fear reflected in risk metrics such as The Alliant Oil & Gas Country Risk Index. This is important as rising levels of geopolitical risk in oil producing countries have historically correlated with higher crude prices [also see Emerging Market ETFs: Biggest Winners And Losers].

Going forward, my view is that oil remains what traders like to call “range bound,” not moving particularly higher or lower. But, if it were to break out of its current range, I believe it is more likely to move higher given rising geopolitical tension. Assuming oil continues to hold at or near current levels, I would continue to advocate that investors take advantage of current prices in large-cap, global energy companies, which can be accessed through the iShares Global Energy ETF (IXC, A).

[For updates on all new ETFs, sign up for the free ETFdb newsletter].

Source: Bloomberg data as of 6/30/2013

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog. You can find more of his posts here.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. The energy sector is cyclical and highly dependent on commodities prices. Companies in this sector may face civil liability from accidents and a risk of loss from terrorism and natural disasters. Profitability of companies in the oil industry is related to worldwide energy prices, exploration and production spending. Such companies may be adversely affected by changes in exchange rates, government regulation, world events, economic conditions and environmental damage claims. Oil and gas exploration and production can be affected by natural disasters and changes in interest rates.