Commodities & Energy Sector

Special Report

The old cyclical market axiom that "nothing cures low prices like low prices" has never held
truer than in today's oil market.

For the month of March, the model outperformed both global and U.S. equities in U.S. dollar terms. For April, the model has further pared back its equity risk exposure, shifting the allocation into cash. While Europe remains the largest equity overweight, there was a modest recalibration to defensive markets such as the U.S. and Switzerland. The allocation to EM was also nudged up a bit, on momentum and valuation grounds. In the fixed-income space, the model is sticking with U.S., Italian and Spanish paper.

Lower oil prices are aggravating financial and social stress in poorer OPEC states, particularly in Venezuela, where the government recently executed a gold-for-cash swap ahead of looming debt payments.

The Fed's decision to scale back intended interest rate hikes reflects economic reality.

The allure of gold equities has risen another notch following this week's dovish shift at the FOMC. After raising interest rates only a few months ago in the face of tight financial conditions, the Fed has backed down, acknowledging global headwinds. However, this flip flop also underscores the Fed's data dependency, which is fostering increased overall policy uncertainty. When combined with the unknown consequences and efficacy of negative deposit rates abroad, the allure of owning gold as a portfolio and currency hedge climbs. At a minimum, the inability of global growth to gain traction underscores that real interest rates, the opportunity cost of holding gold, are likely to stay extremely low, or negative, for a prolonged period. As a result, gold should stay well bid, despite the gains that have already accrued year-to-date. We reiterate our recent upgrade to overweight.

We differ markedly with the U.S. EIA's assessment of the near-term evolution of oil supply and demand.

A Chinese reflationary cycle is unfolding. Capital spending is showing signs of regained vigor, driven by both housing and infrastructure. Chinese PPI deflation will ease further. This will help reduce balance sheet stress of materials producers and boost overall industrial profits. Remain positive on Chinese investable stocks.

The euro stopped weakening in March 2015, which coincided with the ECB starting its asset purchases. Since then, the ECB's incremental policies have been unable to push the euro lower. The price action speaks to the resilience of the currency and indicates that a lot of bad news has been discounted.

The wide WTI - Brent differentials at the front of these respective curves will continue to incentivize crude-oil exports from the U.S. to European refiners, who tend to favor the light-sweet crude coming out of LTO plays.

Expectations of a deepening EM/China growth slump and RMB depreciation have been the key to the selloff in global risk assets. There is no basis for these expectations to improve. Therefore, there are few fundamental reasons for EM and global risk assets to rally much further. Stay put. In Brazil, the impeachment rally is unsustainable and will reverse sooner than later. Stay short Brazilian risk assets.