Maxwell Gold

Director Investment Strategy

Investment Insights May 2017

Energys Shifting Return Drivers

Summary
Changes in the global oil supply dynamic may likely continue Changing Dollar Dynamic
to weigh on the drivers for oil and energy prices.
The rule of thumb known to many investors is that the US dollar
The traditional negative relationship between the US Dollar has an inverse relationship with oil and energy prices. This negative
and oil prices has broken down and is currently positive. relationship was most prominent from 2003 to 2014 (see Exhibit
2). During this period the US current account deficit rose driven by
Roll and collateral yields may see further prominence. oil imports which boosted oil prices. Concurrently, this led to a
large build-up of current account surpluses (held in USD) in oil
The expected global economic backdrop remains broadly
exporting economies increasing supply of USD reducing its value
supportive for the energy sector in coming years. Demand for oil
remains robust driven by further recovery of global growth Exhibit 2: Oils inverse relationship to the dollar was most
accompanied with building inflationary pressures, while efforts to prominent from 2003 through 2014
170
reduce the global supply glut are underway. These changes in US Dollar Index (lhs) 140
160
supply side fundamentals are beginning to unravel and impact Oil Price (rhs)
150 120
some of the traditional drivers of energy returns including the US
140
100
dollar (USD), interest rates, and curve structure. 130
Index Level

80

US$/barrel
120
Fundamentals in Focus 110 60
On May 25th the Organization of the Petroleum Exporting 100
40
Countries (OPEC) agreed to extend production cuts that it initially 90
20
80
implemented in November 2016. This 9-month extension, ending
70 0
March 2018, is a direct response of the changing landscape of
1991

2001
1993
1995
1997
1999

2003
2005
2007
2009
1983
1985
1987
1989

2011
2013
2015
2017
global oil supply dynamics.
Source: Bloom berg, ETF Securities. Data from 12/31/90 to 4 /30/17.
Since enacting these cuts, OPEC production has dropped from 34
to 32 million barrels per day. OPECs strategy, however, has While oil and USD have a -0.11 correlation since 1983, this
resulted in a loss of market share without the commensurate rise in traditional relationship has broken down in recent years and is
price. The rise of North American shale oil and gas production in currently positive (see Exhibit 3). This low and positive correlation
recent years has made this region the current swing producer to the with USD may likely continue with the dollars significance as a
global oil market - a trend likely to persist (see Exhibit 1). driver of oil and energy prices becoming more muted in markets.

Exhibit 1: The role of US production and supply continues Exhibit 3: Oil and USD correlation currently positive.
to grow in importance for global energy markets. Dollar/Oil Dollar/Bloomberg Energy Index
0.4
US Production (rhs) OPEC Production (lhs)
35 10 0.2
34 9
52 Wekk Correlation

0
Barrels per day (millions)
Barrels per day (millions)

33
8 -0.2
32
7 -0.4
31
6 -0.6
30
5 -0.8
29
1992
1990

1994
1996

2002
1998
2000

2004
2006
2008
1984
1986
1988

2012
2010

2014
2016

28 4
2011

2012

2013

2014

2015

2016

2017

Source: Bloom berg, ETF Securities. Data from 12/31/90 to 4 /30/17.

Source: Bloomberg, ETF Securities. Data from 01/01/1 1 to 04/30/17.

1
Past performance is no guarantee of future results.
As the US has ramped up its domestic production since 2010, this Another component for total returns that has diminished over the
has increased its energy self-sufficiency. This changing supply last decade is collateral yield. In the current low interest rate, the
dynamic has simultaneously aligned US growth much closer to yield garnered from holding collateral against futures contracts has
global energy markets, leading the USD to behave more like been minimal. This may see a bit of a reprieve against expectations
traditional commodity currencies. Unlike recent decades, as the of further tightening by the Federal Reserve this year. Additionally
USs role as the global swing producer continues, markets will likely nominal interest rates are a key driver for energy commodity prices
see oil markets continue to be driven more by fundamentals and a rising rate environment may be met with higher prices. Crude
oil and gasoline perform positively on average in rising rate
A return to backwardation? environments while natural gas tends to benefit from falling market
Among the three components of total return when investing in interest rates (see Exhibit 6).
futures contracts (price return, roll yield, and collateral yield), the Exhibit 6: Rising rates may boost oil and energy prices.
roll yield for the energy sector has been a continuous performance Rising Falling
drag over the last decade (see Exhibit 4). Monthly Price Returns
Interest Interest Av erage
(01 /3 1 /9 1 to 4 /3 0/1 7 )
Exhibit 4: Drag on performance. Rates Rates
1,400
Collateral
Energy Sector 0.7 % 0.7 % 0.7 %
1,200 Spot Price
1,000
Roll Yield WTI Crude 1 .4% -0.1 % 0.7 %
Bloomberg Energy Total Return Index
800
Index Price Level

Brent Crude 1 .6% -0.3% 0.7 %

600
400 Gasoline 3.5% -2.5% 0.6%
200
0 Natural Gas -1 .2% 4.0% 1 .4%
-200
Heating Oil 1 .0% 0.4% 0.7 %
-400
-600 Source: Bloomberg, ETF Securities. Data from 01/31/91 to 04/30/17. Energy sector is
represented by the Bloomberg Energy Spot Subindex.
1991

2001
1993

1995

1997

1999

2003

2005

2007

2009

2011

2013

2015

2017

Source: Bloom berg, ETF Securities. Data from 12/31/90 to 4 /30/17.
Oil futures markets are most often in a state of contango, whereby
the futures price is greater than the spot price. When inventors roll
into new contracts at expiration there is an implied cost of buying a
more expensive contract, resulting in a negative roll yield
component to total return.
Exhibit 5: Contango in oil markets continues to fall.
$65
$60
Outlook: Crude Oil
OPECs decision to extend its production cuts through March 2018
was met with disappointment in markets. While this is a positive
sign for the global crude market which continues to rebalance from
a multi-year supply glut, expectations of continued US productions
will remain in focus. There have been encouraging signs in recent
weeks of US inventory drawdowns which if sustained could support
current price levels. Additionally, OPEC has had a poor track record
$3
Contago - WTI Contract (rhs) in keeping compliance to its stated quotas. Lack of follow through
Price - WTI Contract (lhs) on this extended deal by OPEC members may weigh negatively on
Contango/Backwardation Level

$2
$55 prices. With continued tightening fundamentals and reduced
$1
$50 investor sentiment (see Exhibit 7), we expect prices to range from
Price/barrel

$45 $0 $40-55/barrel this year.

$40
($1) Exhibit 7: Oil positioning has unwound recent highs.
$35
500,000 Long Short Net
($2)
$30
Managed Money WTI Oil Futures

400,000
$25 ($3)
Apr-15

Apr-16

Apr-17
Jul-15

Jul-16
Jan-15

Jan-16

Jan-17
Oct-15

Oct-16

300,000

200,000
Contracts

Source: Bloomberg, ETF Securities. Data from 01/01/1 5 to 05/26/17. WTI = West Texas
In t ermediate. 100,000

-
Since oil prices bottomed out in early 2016, the degree of contango
in futures markets has been reduced. Year to date, the oil market (100,000)

has become even closer to backwardation (see Exhibit 5). If global (200,000)

supply is reduced at a higher rate and oil inventories continue to (300,000)

2010

2011

2012

2013

2014

2015

2016

2017
2008

2009

experience drawdowns, this may push the market towards

backwardation thereby bringing roll yield back into focus as a key Source: Bloom berg, ETF Securities. Chart data from 1/1/08 to 5/16/17.
contributor for oil and energy total returns.

2
Past performance is no guarantee of future results.
Important Risks
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of
future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would
be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.
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Commodities generally are volatile and are not suitable for all investors.

Please refer to the prospectus for complete information regarding all risks associated with the Trust.
Investors buy and sell shares on a secondary market (i.e., not directly from Trusts). Only market makers or authorized
participants may trade directly with the Trusts, typically in blocks of 50k to 100k shares.
The Bloomberg Energy Index is a commodity group subindex composed of futures contracts on crude oil, heating oil, unleaded gasoline and natural gas.
Correlation is a measure of fluctuation between two variables. The Organization of Petroleum Exporting Countries (OPEC) is a group consisting of 12 of the
world's major oil-exporting nations. OPEC was founded in 1960 to coordinate the petroleum policies of its members, and to provide member states with
technical and economic aid. Contango is a situation where the futures price (or forward price) of a commodity is higher than the spot price. The opposite
market condition to contango is known as backwardation. "A market is 'in backwardation' when the futures price is below the spot price for a particular
commodity. West Texas Intermediate (WTI) crude oil is the underlying commodity of the New York Mercantile Exchange's oil futures contracts. The spot
price is the current market price at which an asset is bought or sold for immediate payment and delivery. It is differentiated from the forward price or the
futures price, which are prices at which an asset can be bought or sold for delivery in the future. The roll yield is the yield that a futures investor captures as
their long position in a futures contract converges to the spot price; in a backwardated futures market the price rolls up to the spot price, so the roll yield is
positive, whereas when the market is in contango the price rolls down to the spot price, so the roll yield is negative.
Commodities generally are volatile and are not suitable for all investors. This material must be accompanied or preceded by
the prospectus. Carefully consider each Trusts investment objectives, risk factors, and fees and expenses before investing.
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Trust and ETFS Precious Metals Basket Trust.
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ETF001163 05/31/18

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