The Commodity Investor: Three Commodities That Will Underperform In 2013

December 26, 2012

Coffee, sugar and WTI face supply gluts in the upcoming year, which will cause them to underperform.

In my previous column, The Commodity Investor examined the market performance of commodities in 2012 and identified the top three commodities that will likely outperform in 2013. In this week’s installment, I will provide a different type of analysis and focus on the top three commodities that will likely underperform in 2013. For reasons that will be outlined below, these are the three commodities investors should avoid in the new year.

West Texas Intermediate Crude

WTI crude had a decidedly awful 2012: the crude contract is down more than 10 percent for the year. This performance is even more jarring when you compare it with its crude counterpart Brent, which is up more than 1 percent for the year. Why such a lackluster performance, and what can we expect in 2013?

In many respects, WTI has become a victim of its own success. Specifically, WTI is a benchmark used to track oil produced in the United States, specifically in the Texas region. For decades, WTI reflected production figures in Texas specifically and North American generally. For many years, WTI production remained flat and prices kept rising as demand for WTI increased. However, with the advent of horizontal drilling and hydraulic fracking production, WTI has soared. So much so, that the United States may in fact become energy independent in a decade.

All this excess production means that WTI now reflects specific trends within the North American market (for example technological improvements) and fails to address global concerns prevalent in other key markets. As a result, Brent is becoming the go-to benchmark for global oil markets. Brent is now used to price key markets such as Middle East-Europe, Russia-Asia and Africa-Asia, key trade routes that account for more than half of globally traded oil.

Brent has become so dominant that when Europe and South Korea signed a free trade agreement that encompassed oil exports, the oil component was priced in Brent and not WTI. In addition, even the United States government through the Energy Information Administration (EIA) has conceded that Brent is now the dominant global benchmark: in its annual oil outlook report this Department of Energy agency used Brent as a benchmark for its analysis, breaking decades of tradition with WTI.

It’s ironic that the United States’ objective of becoming energy independent is on its way of becoming realized, but at the detriment of its most trusted and reliable benchmark. As more oil is pumped out of North America, The Commodity Investor expects WTI to underperform not only Brent in 2013 but also the broader basket of commodities. For this reason, investors need to really take a hard look at the market fundamentals of WTI before investing.

Sugar

While many agricultural commodities had a record year in 2012, sugar was one of the definite laggards, especially the sugar ETFs. The major sugar ETFs such as iPath DJ-UBS Sugar Subindex (NYSE Arca:SGG) and the Teucrium Sugar Fund (NYSE Arca:CANE) are down anywhere from 15 to 25 percent for the year. The Commodity Investor doesn’t see any major market developments that could reverse this trend in 2013.

The coming year will most likely be marked by global production surpluses, as has been the case since the 2009-2010 harvest. The two major markets to watch are Brazil and India, which are the first and second global producers respectively. While India produced almost 300 million tons of sugar this year, Brazil was by far the global leader with almost 700 million tons produced.

When it comes to sugar, Brazil is by far the most dominant player in this market. Brazilian production remains robust as investments in the country’s production and distribution infrastructure yield benefits. As production increases by almost double digits in Brazil, global consumption is barely increasing by 3 percent annually. This discrepancy accounts for a large part of the price decreases we’ve seen in the sugar markets.

 

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