Things have changed dramatically for investors in the commodity space since the beginning of the year. In oil, for example, calls for oil prices in the teens that were commonplace at the start of the year have all but disappeared. In fact, investors today are hard pressed to find 2016 average price predictions below US$35.
Oil has not been the only commodity to show strength so far in 2016; iron ore, zinc, copper, and gold have also had sustained rallies since early in the year. With sustained periods of low prices putting pressure on producers and leading to inevitable cutbacks in production, the next phase of the commodity cycle is due to play out.
This process, however, will not unfold evenly across commodities, and it will also be very gradual and bumpy within each class of commodity as markets rebalance. For Canadians looking to gain commodity exposure, it is important to not only pick commodities that have good risk-to-reward ratio’s based on their fundamentals, but also to play them through high-quality producers. Here are some of the most favourable options.
Natural gas
Natural gas prices have continued to languish and have not followed oil’s trajectory in 2016. Henry Hub prices are currently around US$2/mmBtu, and they have fallen from a high of $6/mmBtu back in early 2014. These are extremely low prices, and it is important to look back to get a proper perspective of this.
Since the mid-1970s, prices have only neared the $2/mmBtu level a handful of times, and always briefly. This occurred in 1992, 1996, and most recently in 2012 (after which prices rallied to $6/mmBtu as the oversupply quickly turned into a deficit). Prices below $3/mmBtu are an anomaly, and since 2009 they have averaged close to $4/mmBtu.
Currently, there is a large oversupply of natural gas. Natural gas prices near $2/mmBtu are simply too low to sustain production levels, and as a result U.S. gas production has been largely flat over the past year. According to petroleum expert Art Berman, the average breakeven price for producers in the Marcellus region—the most attractive play in the U.S.—is $3.58/mmBtu.
As producers become more depressed, declining production and rising consumption should lead to higher prices as they did during the previous price cycle. For Canadian investors looking to play this trend, Tourmaline Oil Corp. (TSX: TOU) is an excellent option. Tourmaline is currently weighted 88% towards natural gas production and is a low-cost operator with a healthy balance sheet.
Gold
Gold prices are currently about 16% above where they were at the start of the year; current prices are around $1,215 per ounce. This is well off the highs of over $1,800 per barrel set back in 2011.
Analysts at Morgan Stanley are forecasting that gold will move above $1,400 in the next year or two due to low interest rates globally (negative in several cases) and with government bonds showing historically low yields. Central banks have been buying more gold, and many continue to do so as an alternative to currencies.
In addition to this, the supply/demand fundamentals for gold are strong; many have suggested “peak gold” production was reached in 2015. GoldCorp sees global mine production falling 13% by 2022. These trends are supportive for gold prices, and any increase in global volatility should provide further upside.
Barrick Gold Corp. (TSX: ABX)(NYSE: ABX) is an excellent way to play this trend. Barrick (the world’s largest producer) has shifted its focus from costly production growth to a focus on returns, deleveraging, cost reductions, and free cash flow per share. Should this transition coincide with higher gold prices, the upside for Barrick could be substantial.
