Commodities & Energy Sector

A two-speed economy requires selective portfolio construction, favoring consumer-oriented and mainly non-cyclical industries. Put communications equipment on the high-conviction overweight list, and stay clear of refiners.

With the Fed more sensitive to how its policy affects the global economy, and <i>vice versa</i>, we believe monetary policy will remain accommodative to encourage U.S. and EM growth.

The Chinese manufacturing sector has remained under downward pressure, but the stress level has alleviated compared to a few months ago. The Chinese labor market will likely continue to deteriorate, which will force policymakers to stay accommodative. Despite the recent rally, Chinese investable stocks remain exceptionally cheap.

We are recommending profit taking in gold shares after a dramatic surge since our overweight call earlier this year. The long-term outlook for gold remains appealing, given the need for low or even negative real interest rates for a prolonged period in order to restore global growth to trend or above-trend levels. Nevertheless, on an intermediate-term basis, we are concerned that a rise in the U.S. dollar could cap the upside in bullion and related-share prices. Evidence of speculative zeal is mounting. ETF gold holdings have skyrocketed since late-2015, reflecting massive inflows into related funds. Net speculative positions have surged as a percent of open interest (third panel), underscoring that momentum and performance-chasing have turbo-charged the yellow metal's advance. Sentiment toward gold has also spiked. Importantly, relative stock price performance has become extremely overbought. The 52-week rate of change has soared to its highest level in decades. While that upsurge partially reflects a lasting cyclical and structural trend change, an intermediate-term digestion phase is inevitable to relieve overbought conditions in the coming months, with a stronger currency the most likely catalyst. Take profits of 45% and downshift to neutral.

It is dangerous to equate recent equity strength with economic vitality, as history shows that liquidity-fueled equity advances favor non-cyclicals over deep cyclicals. Take profits in gold, buy rails and sell industrial machinery.

The U.S. and the global economies are improving. A synchronized upswing normally trumps the Fed in determining the path for the dollar. U.S. inflation expectations are likely to rise relative to the rest of the world, weighing on the dollar. The risks for EUR/USD have risen. We are hedging our long EUR/USD position by shorting the euro on some crosses. Buy CHF/JPY.

The recent rally in risk assets is walking a very fine line. If the Fed turns more hawkish, or U.S. growth slows, it could fall over.

We are delighted to announce the launch of our newest sector publication, Energy Sector Strategy (NRG). The new Energy Sector Strategy will be complementary to BCA's Commodity & Energy Strategy (CES) and U.S. Equity Strategy (USES) services. NRG will expand our energy-related research into more granular investment themes that are beyond the scope of CES/USES and extend these conclusions to specific equity investment recommendations. The U.S. horizontal rig count (unconventional/shale drilling) has begun to recover in response to oil prices rising off of an oversold trough, but still remains well below the level that would be sufficient to prevent continuing production declines. Capital availability and rising service costs will be moderating factors on the pace of a drilling recovery, but the completion of drilled but uncompleted wells (DUCs) will allow operators to bring on some additional production faster and cheaper than organic drilling programs. Without the impact of the DUCs, we estimate U.S. shale production would continue to decline through mid-2017; with an aggressive DUC completion program (100 wells per month over the course of a year, starting now), overall production would stabilize 3-6 months sooner and at a higher level (300,000-400,000 b/d) than drilling alone. In this environment, we recommend financially strong oil shale producers who will be able to ramp-up reinvestment fastest (EOG, PXD, PE, FANG), as well as the completion and service companies (HAL, SLB, SLCA) that will benefit from the increased oilfield investment more than drillers. To learn more about this new service, please contact Chris Cook (Chrisc@bcaresearch.com).

Clearing the refined-product overhang in the global storage markets is not as straightforward as it used to be: The Kingdom of Saudi Arabia (KSA), China, and India all are making concerted efforts to boost refining capacity, which is leaving them with surplus product that ends up being sold in export markets.

A collection of 10 important charts to monitor closely through the summer months.