Commodity Investment Outlook | December 31, 2014
Focus on Crude Oil
Given the positive price performance of most equity and bond portfolios in 2014 and the lack
of participation by commodities generally, many investors are concerned about commodities
as an asset class going forward. The lack of confidence expressed about future commodity price appreciation lately, while understandable, may be based on emotional, misplaced,
and untimely judgments in our opinion. In this essay, we will delineate the fundamental and
technical factors which we believe are contributing to recent commodity price trends. After
a clear examination of these facts, we invite you to draw your own conclusions about the
prospects for commodity prices moving forward.
A number of different macro events have unfolded leading to the significant and rapid fall of
many commodities. One of the primary drivers of commodity price depreciation has been
the strength of the US Dollar. Since most commodities are priced in Dollars, historically
commodity price movements tend to be inverted to the value of the Dollar--- Dollar up, commodities down in the absence of other factors. When we look broadly at commodity prices
against the value of the US Dollar (calculated via the US Dollar Index) this year, the magnitude
of the movements are inversely proportional. Curiously, most of the appreciation of the US
Dollar took place from the beginning of July through year end, about the same timeframe in
which commodities dropped from the highs made in early June. Essentially, this means that
commodity prices have been just marginally negative this year, if you adjust for the appreciation of the Dollar. Currency fluctuations matter.
115 PORTFOLIO
MANAGEMENT TEAM
Satch Chada
Co-Portfolio Manager
President, Investor Solutions Group
CoreCommodity Management, LLC
Robert B. Hyman
Co-Portfolio Manager
Senior Vice President
CoreCommodity Management, LLC
ALPS | CoreCommodity
Management CompleteCommodities
Strategy Fund
Class A – JCRAX
Class C – JCRCX
Class I – JCRIX
115 110 Fund Inception Date of June 29, 2010
105 100 95 100 US Dollar Index Bloomber Commodity Index (TR) 110 105 90 95 85 80 Dec-­‐13 Jan-­‐14 Feb-­‐14 Mar-­‐14 Apr-­‐14 May-­‐14 Jun-­‐14 Bloomberg Commodity Index Total Return Jul-­‐14 Aug-­‐14 Sep-­‐14 Oct-­‐14 Nov-­‐14 90 Dec-­‐14 US Dollar Index (DXY) Data range: 12/31/13 – 12/31/14
Data Source: Bloomberg LP; Values normalized to 100 at 12/31/2013
*The US Dollar Index indicates the general international value of the US Dollar. The
index is calculated by averaging the exchange rates between the USD and six major world
currencies. The Intercontinental Exchange computes the index using rates supplied by
some 500 banks.
The US Dollar enjoyed one of its best upward runs in history this year. At one point this fall, the
value of the Dollar was up for more than 10 consecutive weeks, the longest positive stretch since
the Bretton Woods currency agreement in 1971 (Bloomberg.com). The same macroeconomic
factors which led to Dollar appreciation may have held commodity prices back: (1). The Federal
Open Market Committee (FOMC) ended their quantitative easing (QE) policy in which Treasuries
and mortgage-backed securities were purchased by the Fed to support bond prices and to keep
interest rates low; (2) Better news on unemployment data and improved economic activity led
the FOMC to sunset the QE program and speculation began about possible US rate increases
sometime in fiscal 2015; (3) By contrast, Europe, Japan, and certain emerging market countries,
www.alpscommoditystrategy.com | 1.866.759.5679
ALPS | CORECOMMODITY MANAGEMENT
COMPLETECOMMODITIES® STRATEGY FUND
Commodity Investment Outlook | December 31, 2014
including China, struggled with sluggish growth; and (4) Additional stimulus efforts were implemented and are still being contemplated outside of the US.
The divergent outlooks for global interest rates are driving the value of the Dollar higher against the major world currencies.
The price of crude oil has been one of the dominant stories in finance this year and the focus for most of the concern in the commodity asset class. For
the 2014 calendar year, the price of West Texas Intermediate crude oil (WTI), the US benchmark crude, dropped 45.87%.Fundamentally, crude oil prices
are being pressured lower by both supply and demand issues. On the supply side, North American production, primarily resulting from technologybased advances in hydraulic fracturing (fracking), horizontal drilling, and oil sands recovery, has enjoyed a surge of almost 1 million (mm) barrels a day
increase on a year-over-year basis. The Department of Energy reported that US production had increased to approximately 9.1 mm barrels/day. That
amount places the US amongst the top three producers in the world along with Saudi Arabia and Russia. Conversely, the demand for crude oil has
been subdued. The incremental gain in production by the US might ordinarily be absorbed into the global total without much of a ripple, if global GDP
had been more robust. The International Energy Agency (IEA) has lowered its projections for future crude demand based on the anemic figures from
various parts of the globe. The world currently consumes approximately 90 mm barrels/day (IEA). The lowered demand calculations call for just a 1.5%
increase for calendar 2015. While that is up more than 1 mm barrels/day overall, it is close to the projected increases that may be possible just in
North America.
Continued increases in oil production require reasonable return on investments. Oil Exploration & Production (E&P) is a capital intensive business and
companies need to show projected returns before moving forward with new projects. The current price environment makes that challenging. We calculate that many of the most important “fracking fields” are already below marginal production costs. Remember, the published price of WTI may not
accurately reflect the price producers receive at the wellhead. In fact, the discount attributed to gathering, transportation, storage, and insurance may
be significant. The realized price per barrel of crude oil received by producers is well below $50/barrel now, in many cases.
$46 $32 $40 $43.5 $45.5 $43.2 $42.7 Spot prices as posted on Bloomberg, as of 1/13/2015
Sources: EIA; Bloomberg LP; CoreCommodity LLC
Oil production companies are beginning to respond to the price drop that has taken place over the past few months. Rig count, the number of
operating “drill-rigs”, have been falling over the last few weeks.
www.alpscommoditystrategy.com | 1.866.759.5679
ALPS | CORECOMMODITY MANAGEMENT
COMPLETECOMMODITIES® STRATEGY FUND
Commodity Investment Outlook | December 31, 2014
Number of Baker Hughes Oil Rigs
Data Range: 1/3/2014 – 1/3/2015; weekly observations
Data source: Baker Hughes; Bloomberg LP
Prices below breakeven production costs are causing a reasoned slowdown in new crude oil exploration and drilling. Existing wells with sunken
costs may continue to pump at low price levels until depletion. Changes in the corporate bond market, specifically high yield energy related issues, are reflecting the risks and concerns amplified by the large price decreases in oil prices. “Back in June, the average junk bond yield was
3.90 percentage points higher than Treasury securities. The average energy junk bond yielded 3.91 percentage points higher than Treasuries.
That spread has widened to 5.08 percentage points for junk bonds vs. 7.86 percentage points for energy bonds — an indication of how worried
investors are about default, particularly for small, highly indebted companies in the fracking business.”* the change in bond market sentiment
about the riskiness of oil and gas E&P has effectively added additional barriers to entry.
Lately, the public mood about crude oil prices has been decidedly bearish. The failure of the Organization of the Petroleum Exporting Countries
(OPEC) to respond to falling crude prices with any production cuts at its last meeting on Thanksgiving has increased the negative attitude. To
many observers, many sovereign oil producers seem to be caught in a spiraling vortex: swelling domestic social agendas are predicated on
receiving hard currency from crude oil sales. Russia, Venezuela, and Libya come quickly to mind. With prices coming down, their cash needs
become more desperate. Desperation may lead to further discounting of prices and maximizing sales volumes.
Saudi Arabia has been singled out as one of the primary players contributing to the accelerated decline in oil prices, especially since the OPEC
meeting. The sizable oil revenue contraction has effectively inflicted economic pain against potential competitors, both short- and long-term.
Their financial positions are quite vulnerable and fragile in this low crude oil price environment. For now, Saudi Arabia can withstand its own revenue loss because of massive cash reserves it has built up over the years. Still, they are motivated to increase revenues in the long run through
possible price appreciation and maintaining or enlarging market share.
Given the voracity of the price move in crude oil in the last six months, it’s fair to ask what material changes regarding inventories and apparent
demand have registered statistically. The 2014 highs for crude oil were reached in early June. The Department of Energy (DOE) reported total US
crude oil inventories, including the Strategic Petroleum Reserve (SPR), was 1.077 billion barrels on June 13, 2014. Domestic refineries operated
at 87.10% capacity during the same reporting period. The last reported levels for the year, Dec. 26: inventories were 1.076 billion barrels and
capacity utilization was 94.40% (DOE, Bloomberg). While seasonal factors typically show draws in crude oil inventory near yearend, the fact that
the numbers have hardly changed is noteworthy. Higher capacity utilization is also expected near yearend. The 7%+ increase in refinery runs
from June shows that demand, at least in the US, has not fallen off dramatically. Globally, studies show that demand increases by about 35 basis
points (0.35%) for every 10% lower price adjustment. Typically, demand begins to register 4-6 months after the price moves. China, the rest of
Asia, and India are the largest consumers responsible for this reaction. (IEA & Bank of America/Merrill Lynch) The crude oil move since the end of
October has been more than 35%. That would suggest a bump up in incremental demand of more than 1% globally, or more than an additional
1 mm barrels/day, probably by the second quarter of 2015.
It is impossible to pinpoint exactly when crude oil prices might bottom and trade higher. A great deal of fundamental factors, externalities, and
emotion can contribute to price swings. The demand for crude oil has been disappointing relative to previous expectations, but it is expanding.
Economic realities have begun to reduce permits and rig counts. Capital expenditures for exploration and production are being cut. Supply/
demand imbalances exist, but in our opinion, they do not seem commensurate with the magnitude of the recent sell-off.
* Source: USA Today December 18, 2014.
www.alpscommoditystrategy.com | 1.866.759.5679
ALPS | CORECOMMODITY MANAGEMENT
COMPLETECOMMODITIES® STRATEGY FUND
Commodity Investment Outlook | December 31, 2014
IMPORTANT DISCLOSURES
Investors should consider investment objectives, risks, charges and expenses carefully before investing, including “Additional Risks” as described
in the prospectus. To obtain a prospectus, which contains this and other information, call 1.866.759.5679 or visit www.alpsfunds.com. Read the
prospectus carefully before investing.
ALPS Advisors, Inc. and CoreCommodity Management, LLC are registered with the CFTC as the Commodity Pool Operator and respectively as the Commodity
Trading Adviser and both are NFA members.
Satch Chada and Robert B. Hyman are registered representatives of ALPS Distributors, Inc.
The Fund’s investments may subject the Fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including
risk of a significant portion on their principal value.
The commodities markets and the prices of various commodities may fluctuate widely based on a variety of factors. Because the Fund’s performance is
linked to the performance of highly volatile commodities, investors should consider purchasing shares of the Fund only as part of an overall diversified
portfolio and should be willing to assume the risks of potentially significant fluctuations in the value of the Fund. The Fund invests in commodity
futures related investments, which are derivative instruments that allow access to a diversified portfolio of commodities without committing substantial
amounts of capital. Additional risks of Commodity Futures Related Investments include liquidity risk and counterparty credit risk. Counterparty Risk is
the risk that a party to a transaction will fail to fulfill its obligations. The term is often applied specifically to swap agreements in which no clearinghouse
guarantees the performance of the contract. Liquidity Risk is the risk stemming from the lack of marketability of an investment that cannot be bought or
sold quickly enough to prevent or minimize a loss.
Another principal risk of investing in the Fund is equity risk, which is the risk that the value of the securities held by the Fund will fall due to general market and
economic conditions, perceptions regarding the industries in which the issuers of securities held by the Fund participate or factors relating to specific companies
in which the Fund invests. The Fund’s investments in non-U.S. issuers may be even more volatile and may present more risks than investments in U.S. issuers.
Equity investments in commodity-related companies may not move in the same direction and to the same extent as the underlying commodities.
Bloomberg Commodity index (TR): an unmanaged index used as a measurement of change in commodity market conditions based on the performance of a
basket of differet commodities.
ALPS Portfolio Solutions Distributor, Inc. is the distributor for the ALPS | CoreCommodity Management CompleteCommodities® Strategy Fund. ALPS Advisors,
Inc. is the investment adviser to the Fund and CoreCommodity Management, LLC, is the investment sub-adviser. ALPS is not affiliated with CoreCommodity
Management, LLC. CoreCommodity Management, LLC, serves as investment adviser to the Fund’s Cayman Islands subsidiary. “CompleteCommodities” is a
service mark of CoreCommodity Management, LLC.
Not FDIC Insured • No Bank Guarantee • May Lose Value
One cannot invest directly in an index.
JCI000282 | 04.30.15
www.alpscommoditystrategy.com | 1.866.759.5679