It is no news that commodity prices are volatile and unpredictable. Countries which are dependent on the extraction of natural resources have their faith linked to the price of a particular commodity or a group of commodities. The end result of a shock in the price of a commodity is usually adversity across the producing nation and its citizens. The opposite holds true when commodity prices trade at high levels for long. The price of oil was a case in point during the first decade of the 21st century when resource-rich countries benefitted from high commodity prices. During this period brent crude oil reached a high of nearly $144 in 2008.

During the last 10 years the price of oil was not as benign. Brent crude oil has been on a roller-coaster since the last financial crisis, during which the price of oil tumbled, as oil traders expected demand to decline on recessionary fears. Since then it recovered ground and back in June 2014 brent crude traded at $115 a barrel but again hit a multi-year low in early 2016 as it hovered around the $30 level. The sharp sell-off came on the back of global growth worries and at a time when global demand was due to turn negative.

However, over the last 18 months the price of oil had a positive run.

As is usually the case, political issues contributed to the jump in price, as trade tensions together with political and economic sanctions on Iran by the US, loomed over markets from the start of the year. During the first nine months of the year alone, the price of brent crude oil spiked by 28 per cent.

Sanctions on Iran have a direct impact on the crude oil market as US sanctions ban countries from buying crude oil from Iran. The consequence is lower demand for Iranian oil and hence lower daily oil supply. Because of these sanctions various countries have already reduced or stopped purchasing Iranian oil altogether. In fact, part of the climb in the price of oil could be attributed to concerns that producers will not be able to fill in the output gap caused by the drop in Iranian oil exports once the sanctions kicked in.

However, what we witnessed over the past six weeks is a partial reversal of the surge in price recorded till the beginning of October. This notwithstanding the fact, that sanctions on Iran came in to place earlier this week.

Various market participants believe that lower supply from Iran will be more than made up for by other oil producers. In addition, the expectations of slower economic growth, all things being equal, also mean lower demand for oil. Moreover, Washington has also agreed to relax somewhat its sanctions and let eight countries continue buying Iranian oil. China, the largest buyer, is among the eight countries.

Declining oil prices is a boon for consumers and curse for producers. The latter includes major oil exporters such as Nigeria, Venezuela and Russia.

The negative political and economic impact which very low oil prices had on Venezuela in recent years are widely known.

Because of the nation’s dependence on the oil industry, the state cut public spending massively, which in turn created shortages and impressive increases in the prices of goods and services.

The country was on the brink of civil war. Countries which are highly dependent on the price of a volatile commodity, such as the price of oil, should find ways to diversify their revenue streams to mitigate the negative consequences of declining commodity prices as much as possible.

Washington has agreed to relax somewhat its sanctions and let eight countries continue buying Iranian oil. China is among the eight countries

Investors should always keep in mind that commodity investing is a risky strategy which usually does not yield income. An investor who wants portfolio exposure to a particular commodity can invest in shares of companies which operate in that particular sector.

However, holding direct shares of a listed company will add more layers of risk, such as default and concertation risks. Risks can be mitigated, but not reduced completely, if exposure to commodities is accessed through an investment fund or exchange traded product. Such investments will reduce default and concentration risk, while at the same time give the portfolio exposure to a particular commodity or a number of commodities.

Investors who opt for a commodity fund with exposure to the oil industry will own shares of companies which are involved in oil exploration, refining, equipment storage and distribution.

While the fund will fluctuate more or less in line with the value of the commodity, default and concentration risks are lower, and the level or gains or losses will not necessarily mirror the movement in the price of oil.

If one is still uneasy with a commodity fund in one’s portfolio, because of the volatility it is expected to exhibit, one should at least consider a multi-asset fund which among the mix of different asset classes holds shares of companies whose profits are linked to commodities and energy. Such assets tend to provide an element of protection against higher inflation. In fact, with higher inflation fears more evident than ever, investing in commodities can also mean a potential hedge against inflation.

Higher inflation is generally not positive for bonds and shares, but can often mean higher commodity prices. Historically commodity prices have exhibited not so strong a correlation to high quality bonds and shares and hence can provide true diversification when you really need it. However, hold tight, the roller-coaster ride may not be over yet as political risks and growth concerns continue to leave their mark on the price of oil.

This article was prepared by Gabriel Mansueto, Branch Manager and Senior Investment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on 2122 4410, or e-mail gabriel.mansueto@jesmondmizzi.com.

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