Revisiting oil

Back in 2015, the below framework was used to explain the c2014 oil market correction. Tighter US monetary policy, at a time of weaker China data, as the primary macro-centric argument for the collapse. You also had idiosyncratic supply-side issues (+US shale, -OPEC response).

The supply side factors are not so binding, now (e.g. OPEC cuts), but the macro side factors are much more harsh. Vastly more aggressive, and, based on Fed speak, persistent, tightening. I struggle to see how they would largely net out, to leave oil around current levels…

And to that point about the China data, here’s what it looks like. Of course they are reopening. Of course they are trying to stabalise/pump/reinvigorate property and infrastructure. Because the alternative is economically quite grim, as per the below data trajectory.

Which is ordinary on almost every frame you care to think of. Although my point was about oil, and macro, mainly, it also extends to commodity prices like iron ore, which, to me, have overshot to the moon on hope of a sustainable turnaround, a turnaround that is impossible because of changed forward looking expectations for house price appreciation on the behalf of China’s households. Demand is weak, and all the supply side measures in the world aren’t going to change that.


Now, the market doesn’t care about my opinions. Oil and gas, and iron ore, are the trades that have worked.

But, at the same time, I think you just have to follow your process. My analysis of the above suggests great caution. We are allocated to stocks, in our direct equity sleeves, that will do well, if not brilliantly, in an environment where everything turns out fine.

If the economy doesn’t tank, then the pointier sectors like commodities (and to a lesser extent other cyclical plays like consumer discretionary) will do very well, and our absolute returns will be fine but relative performance will suffer, as the higher beta names perform better. I am comfortable with that relative risk.

Our active manager exposures will likely be somewhat similar. I think of Allan Gray, a value manager we have on, that is loaded with commodities (oil and gas, mostly, but also fertiliser, steel, that sort of thing), which would do fine, but IML, the quality + value manager, is a) currently running a 16% cash position and b) no iron ore, will almost certainly do less well, which nets out for the most part (but, crucially, still giving us good benefits from diversification of imperfectly correlated strategies, which matters for the risk adjusted returns).

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