The global financial crisis has had a severely damaging effect on commodities funds. Fundamental demand/supply imbalances have been ignored and capital flows have been redirected away from long term capital intensive projects, such as commodity based infrastructure, towards other areas. Many asset managers have suffered, but there are reasons to be bullish about the long term with development across emerging markets fuelling ever greater commodities demand. MENA Fund Review spoke to Anric Blatt, chairman, Global Fund Exchange, Brian Fudge, investment products manager at AMT Futures Limited, and Andrew Brudenell, manager, HSBC GIF Middle East and North Africa fund about the future of commodities funds in the Middle East and North Africa
COMMODITY funds experienced mixed performance last year. The majority lost money, with some larger players posting double-digit losses. Many managers failed to navigate the Arab Spring and Eurozone crisis and the resulting poor performance continued for many into the first quarter of 2012 as equities rallied leaving commodities lagging.
Concerns over commodity consumption fuelled by reduced GDP forecasts for some of the big commodity consumers such as China and Brazil compounded the issue. In addition, many commodity funds failed to take advantage of the first quarter rally in crude oil combined with a drop in market volatility, due to political concerns and a reduced appetite for risk.
Despite this, some funds have bucked the trend and performed well throughout a difficult environment, according to Anric Blatt, chairman, Global Fund Exchange. "In 2011 some of the largest, most well-known multibillion dollar commodity funds posted double digit losses, whereas many smaller, more nimble specialist funds outperformed considerably," he says. "We believe this recent dip in commodity fund performance has created a buying opportunity for our long term holdings and are looking to increase our exposure to commodities including agriculture and water."
The next 12 months will continue to be difficult for commodities managers, with a mixture of more positive as well as negative factors influencing opportunities. The Eurozone risk continues to be a factor and while oil fundamentals are strong due to global growth this could be threatened by soft US economic data and a correction in the S&P, according to Blatt. Gold could see a rally in the second half of the year, he believes, on the back of a sell-off in equities and heightened Eurozone headline risk. Copper scarcity too is likely to remain an issue throughout the rest of the year, according to Blatt. "This is important in the MENA region, as copper is in significant demand for use in construction and infrastructure projects, which are sorely needed as the region continues to grow. As a result, the MENA region's first ever copper contracts went live on April 20, 2012, and will be cleared by the Dubai Commodities Clearing Corporation."
One focus of Global Fund Exhcnage's Aquaterra fund is agriculture, a sector Blatt and his team believe there are considerable opportunities in. "Despite a tough start to the year, we find the agricultural sector compelling, in particular agricultural inputs such as fertilizers and investments in water entitlements," he says. "The warm global weather may also yield better crops than previously expected; as a result we continue to monitor these reports very closely."
The global financial crisis had two effects on the commodities funds sector last year: commodities markets priced in slow growth and ignored fundamental supply/demand imbalances; and the crisis re-directed capital flows towards the perceived safe haven of sovereign debt and away from longer term capital intensive projects such as commodity based infrastructure.
"The Arab Spring was partly driven by agricultural commodity price inflation and those governments that remain in power are redoubling their efforts to ensure better supplies, building grain silos, etc," says Blatt. "The effects, while not permanent, should last for several years to come." Pressures on energy and other strategic resources are mainly geopolitical today, according to Brian Fudge, investment products manager at AMT Futures Limited. "Political turmoil in the Arab world is proving to be inextricably linked to the level of hydrocarbon wealth a country possesses in relation to its population. "Equally, a MENA driven oil shock will add pressure on the G20 to stabilise the European debt markets. Further, a break in the global supply chain of Iranian oil would send prices soaring, possibly halting US growth. This is going to be the case for the foreseeable future and will both increase the urgency to manage MENA resources efficiently and politically as well as drive wealth to be invested in global strategic commodities."
Rapid growth in China, India and other developing economies will inevitably increase competition for diminishing resources both exported by and used domestically by other fast growing countries, including many across the MENA region. "Global and domestic demand will certainly see commodity price increases and the need to innovate politically, democratically and economically throughout MENA," according to Fudge.
This increase in demand for energy and natural resources could present a huge opportunity for resource rich MENA countries that export oil and natural gas. "However, increased demand for resources from emerging markets has also led to high inflation rates in resource-poor countries in the MENA region that have a high dependency on food and fuel imports," adds Blatt. "Increased costs in these resources was one of the factors that sparked the Arab Spring. Rising incomes and the expanding middle class in emerging countries combined with continued instability in the MENA region is a recipe for continued increases in fuel and food prices."
There have also been concerns recently about a slowdown in the Chinese and Indian economies and what effect this might have on commodity prices. "Despite reduced GDP forecasts, China still expects to grow at 7.5 percent this year and India by 6.9 percent in 2012. It is important to remember that these numbers represent an annual growth rate and the market base in these countries has been expanding every year for quite some time, providing steady demand for energy commodities," says Blatt.
"China has grown on average 10 percent per year over the past 33 years with the best years following leadership changes and reforms. Q1 results have eased many fears of a hard landing in China and a leadership change at the end of this year should speed up the implementation of planned reforms." While falling demand for exports from Europe has had an impact on China's export-driven economy, this has been offset by a moderate recovery in the US, giving hopes to a soft landing in China that would have less of an impact on commodity prices than a hard one.
Another opportunity for commodity managers in the MENA region comes from natural energy sources; primarily solar power. There has been a large amount of investment in alternative energy sources across the MENA region in recent years, driven partly by the fact that several countries in the region are among the largest consumers of oil per capita in the world.
"There is significant opportunity to take advantage of the abundance of sunshine in the region and offset the regions energy costs, in order to continue to export fossil fuels elsewhere for profit," Blatt says. There are a number of commodity trends that will impact the Middle East and North Africa over the long term. The super-cycle in commodity prices that has taken place over the last decade or so has benefited a number of emerging and frontier economies including some of those in the MENA region," according to Andrew Brudenell, manager, HSBC GIF Middle East and North Africa fund.
"The large net exporters of oil and gas in the GCC, like Qatar, Saudi and the UAE have built up considerable cash reserves over the years and this has enabled them to expand their budgets over time. The authorities have recognised the need to invest in infrastructure and various industries to diversify and grow their economies and have the means with which to do so. This has resulted in robust GDP growth across a broader economy and many of the listed companies in the GCC are benefitting from this.
"In terms of changes in the oil price and the impact it could have on these growth plans, the key is the absolute level of the oil price. Our view is that for the budget plans of the GCC nations to be changed materially, resulting in a pull back in spending and therefore growth potential, the oil price would have to fall significantly and, importantly, remain there for some time."
The level required for this change varies by country and is speculative but an oil price sustainably below $85 would be needed to impact the Saudi budget and somewhat lower for the Qatar and UAE, according to Brudenell. This means a lower oil price would be an issue for the region but at present it is not a high risk factor.
"In turn higher oil prices further support the growth story in the GCC, particularly if it is a slow and steady rise, rather than a shock spike up which could damage the global recovery and trade," he adds. "Conversely, for the importing nations within the MENA region, higher energy prices are a risk to inflation and demand growth. A number of countries subsidise energy, like Egypt, so further price rises will have a negative impact on their budgets."
Rising demand will be a major consideration within the commodities sector in years to come with energy demand on track to increase 50 percent by 2030, according to Blatt. "Over 75 percent of new demand is being met by traditional energy sources," he says. "Although this number is expected to fall over the next 20 years, energy agencies around the globe still believe that traditional energy sources will continue to meet the majority of demand. 93 percent of new demand is expected to come from non-OECD economies. This continues to be a positive long-term trend for the MENA region."
The launch of the City of Masdar in Abu Dhabi will also have significant impact on the commodities sector. With its creation comes one of the world's leading centres for global renewable energy research and as a result the region continues to promote and develop solar and wind alternatives to subsidize their domestic needs.
"The MENA region is experiencing population growth at a rate of two percent per year, second in the world only to Sub-Saharan Africa," says Blatt. "Nearly seven million people are being added to the region every year. Per capita electricity consumption during the period 2007-2035 in the GCC is likely to increase at an annual rate of 2.5 percent. As a result, utilizing alternative forms of energy becomes a major focus. The emergence of alternative power sources will enable GCC nations to successfully diversify their economic growth from a predominantly oil based economy thus bracing themselves against future adversities arising from oil fluctuations. In the short-term it will allow for more fossil fuels to be exported."
Perhaps unsurprisingly, water scarcity will also be a driving factor in the commodities sector. The MENA region is one of the most water-scarce regions of the world, and the Middle East has the highest level of desalinated water in the world at 70 percent of all worldwide capacity. "Spurred by a buoyant economy and population growth, over $300 billion will be invested in the GCC water and desalination projects, between the 2012 - 2022 periods," says Blatt. Blatt's long term outlook on commodities is bullish, based on burgeoning populations and continued industrialization of China, India and South East Asia.
"Despite a slowdown, these regions continue to grow at a steady pace," he says. "We do expect continued volatility, which is why we invest in commodity trading managers who can capture returns in bull and bear markets. No matter what the outlook for the next 12 months, we expect to make money in commodities. Ultimately, we believe that getting the short-term right is key, and managing the volatility is a top priority."
© MENA Fund Review 2012
