Mark Burgess

We continue to live in a world of extraordinary monetary policy, where investors are no longer surprised by central bank easing and, indeed, have come to expect it.

Thus the equity market rally continued into August, buoyed in the UK by the widely expected announcement of a Bank of England base rate cut to 0.25% – the lowest it has been in the Bank’s 322-year history – along with the expansion of quantitative easing. That made for a package of complementary measures that is impactful for the UK economy.

Bond yields have fallen very sharply, supported by easy monetary policy across Europe and Japan, which in turn is underpinning yielding assets, whether that be equities or credit; with the BoE’s quantitative easing propelling yet another strong rally across core government bonds.

Recent data showing a resumption of strong jobs creation has underpinned the outlook for the US economy, and there is growth coming through in the US, albeit at lower levels than we might have seen historically. We know the Fed is looking to normalise monetary policy and raise interest rates, but its ability to do that is somewhat hampered by the aforementioned monetary policy conditions elsewhere, which may hold the Fed back in the short term. We continue to expect one rate rise this year and two in 2017.

Globally, divergent monetary policy is going to be a major influence on asset classes, with investors having ever fewer places to go in their quest for yielding assets. In my view, this will continue to be the dominant theme in the global economy for the coming months and maybe years.

Having been neutral since February, we think the US dollar is likely to trend gently higher, driven by capital flows rather than growth or monetary policy divergence, and we have lifted our weighting to a modest favour from neutral previously. But we are mindful of what this might mean for risk assets which, from a valuation perspective, are mostly at near-time or all-time highs already.

Commodities

Gold aside, commodities stand out as one asset class that has yet to see an uplift. We see commodities as a useful portfolio diversifier and are mindful of its ‘catch-up’ potential, so we have lifted our allocation to the asset class. At a broad level commodities rallied from 2000 to 2008, driven by the rapid industrialisation and urbanisation of China, but as the pace of this levelled out commodities entered a bear phase and now almost every commodity is trading below its 15-year median trading level, aside from gold, coffee and cotton. Energy in particular is trading well below its median level.

There are compelling reasons for a more favourable outlook. The key drivers of a commodity bull market are a drop in production coupled with increased demand. Since 2012 there has been a dramatic change in capital expenditure among mining companies, with capex falling by nearly 90% in four years. Against such a drop in demand, supply had to fall – but this has taken time.

Excess supply of oil is now falling, in part due to the price war that drove many uneconomic shale fields out of production, and US domestic production is expected to fall significantly this year. That leaves fewer oil producers left to turn on the taps. To put today’s oil market dynamic in context, during the oil bear market of the 1980s there were up to 15 million barrels per day of spare capacity and we were only consuming 60mbpd globally. Now, on a global basis we are consuming around 95mbpd and there is only around 1mbpd of spare capacity. Therefore, in our view a reversion to a $30 oil price would require an unforeseen collapse in demand – at a time when demand for oil continues to be revised higher as consumers react to the lower price environment. Emerging markets are key drivers of this demand.

In our view, we are now at the point where the supply/demand dynamic is rebalancing across commodity sectors, including the base metals markets.

Gold demand is soaring, and coming predominantly from investors via ETFs. Total demand in the first half of the year hit a new high, eclipsing the previous record set in 2009. Clearly, seven years ago we were in the midst of the Global Financial Crisis and there are parallels today: like then, investors clearly see gold as something of a safe haven amid dwindling bond yields and volatility across risk assets.

Investment demand drives gold rallies and the ‘lower for longer’ dynamic that we see playing out for the foreseeable future will continue to concern investors. Our world of extraordinary monetary policy and negative interest rates is new territory for many investors and so we do not envisage demand falling; instead we see it benefiting as part of a broadly-based commodity rally.

By Mark Burgess, Chief Investment Officer EMEA and Global Head of Equities

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