Quantix Q4 2024 Newsletter

It’s become a Quantix tradition to dedicate the first newsletter of the year to a ‘State of The Markets’ address. In keeping with that tradition, I will offer some insights into the themes we expect to impact commodity markets in the upcoming year. Most importantly, we anticipate shifting market dynamics to potentially generate significantly greater opportunities in commodity markets in 2025.

Source: Bloomberg, calculations by Quantix Commodities LP

2024 was, at least superficially, a relatively lackluster year for commodities, with the Bloomberg Commodity Index (“BCOM”) trading in a narrow 14.1% max to min range and ending the year flat (+0.12%). As seen in the chart on the right, this was the smallest range in Quantix’s five full years of trading history (2020 to 2024). In contrast to previous years, where the high (in the case of 2020 or 2023) or the low (in the case of 2021 or 2022) was set at the start of the year, there was no obvious direction to commodity markets in 2024.

Investors’ attention and capital appeared largely focused on US equity markets that left nearly every other asset class in the dust. US exceptionalism, bolstered by the performance of the ‘Magnificent 7’, drove the S&P 500 Index +23.3%, while both global equity markets (Euro Stoxx Index +6.6% and China Shanghai Composite +12.7%) and commodity markets lagged.

As discussed in previous letters, there were some notable exceptions in commodity markets as Cocoa (+319%), Coffee (+78%) and Gold (+20%) made all-time highs, but more broadly, we saw the opportunity set for commodity strategies as relatively lower than it has been in recent years. For broad basket commodity strategies, the lack of scarcity, particularly in oil and agriculture, contributed to the muted returns. Indeed, if this letter had been written in December, it would have focused on the theme of debasement as broad-based scarcity remained less relevant.

However, the environment is rapidly changing. In January alone, potential US tariffs have raised the possibility of scarcity in the Petroleum sector. Dramatically colder weather in the US has impacted the Natural Gas markets and Grain yields have suffered historically large downward revisions. This has led to a correlated strengthening of spreads in commodity markets, building significant risk premium across many different commodity curves at the same time.

Overall, greater macro and political uncertainty is appearing to generate greater volatility and upside momentum to commodity markets, and we believe that 2025 could be much more active than 2024 and ripe with potential investment opportunities. Even in 2024, beneath the subdued market performance there were subtle - yet significant - shifts in the structure of various commodity market segments that can inform investment strategies and, in most cases, provide a bullish price catalyst for the foreseeable future.

In this newsletter, I will conduct a sector-by-sector examination of these changing dynamics and discuss their implications for investing in commodity markets.

State of the Markets

2025 has started with a flurry of significant, market moving events. While the time period is a short one, BCOM rallied 5.4% (nearly 40% of last year’s entire range!) in just 10 trading sessions to start the year and we believe that there are numerous signs suggesting the path for commodities is higher.

Oil: OPEC policy has always played an important role in determining the dynamics of the oil market but the implementation of their current production-cut strategy is a bit unusual. Typically, production tends to be curbed after inventories rise due to a supply/demand imbalance. In these environments, the crude oil forward curve is usually in a state of contango (with forward prices higher than spot prices) when production cuts are invoked.

However, for the past year OPEC has implemented significant cuts (and extended them recently) despite global inventories being historically low and the crude oil forward curve in a state of backwardation (with forward prices lower than spot prices). The typical market response to this would be to send prices materially higher but, until recently, poor demand expectations - principally out of China as it struggles to boost consumer sentiment - have kept a lid on price appreciation.

This atypical policy has resulted in a significant effect: the crude oil futures curve has remained backwardated while flat price has been range-bound. Markets remain tight with low inventories leading to backwardation but investors are unwilling to buy the forward curve (and thereby boost flat price) likely because of the shadow of the huge OPEC spare capacity and lackluster demand expectations.

This effect is best observed in the performance of the BCOM Petroleum subindex relative to BCOM Petroleum Spot price index (chart below). The positive roll-yield coming from the backwardated state has meant that investors holding and rolling Petroleum contracts actually earned a positive return (+3.9%) in 2024 even as spot prices for these commodities dropped (-3.4%).

BCOM Petroleum Subindex (BCOMPE) vs. BCOM Petroleum Spot Price Index (BCOMPESP) Prices: December 29, 2023 – December 31, 2024

Going forward, we believe the current market dynamic could not only deliver a positive roll-yield but may also likely be quite bullish for oil prices over the longer term as lower forward oil prices disincentivize cap-ex decisions and discourage investment in production.

US production (chart, above) is already starting to plateau with incremental barrels in 2025 projected to be the smallest in a non-COVID year in nearly a decade.

The new administration’s desire to increase US production will likely not be easily achieved without higher prices. OPEC+ producers are also being affected by their policy as Russian operators reported a 12% decline in new well completions year-over-year.

Natural Gas: The US Natural Gas price curve has also undergone a significant transition relative to prior eras due to unusual circumstances.

The rapid growth in fracking and Liquefied Natural Gas (“LNG”) terminals has led to large increases in both supply and demand. So fast, in fact, that production has doubled in a decade (chart below), and much of the infrastructure required to deliver or store gas to match the new sources of supply and demand has not developed at the same pace.

U.S. Dry Natural Gas Production: 2010 - 2024

As a result, there is the need for far greater seasonal price dispersion between the high demand winter months (as demand is higher) and low demand summer months (as supply is higher).

Interestingly the forward curve in 2015 for US Natural Gas prices (orange lines on chart below) showed Winter 2026 prices at a very similar price to where they are today at USD4.60/mmBTU (white line on the chart). The seasonal discount to summer gas prices, however, was significantly less in 2015 relative to the current curve, with Summer 2025 prices roughly USD0.85/mmBTU (25%) higher than they are today.

U.S. Natural Gas Henry Hub Futures Pricing

While this new structural dynamic has major implications for curve trading, weather remains the dominant factor in setting absolute price levels in Natural Gas. The general trend of global warming has meant that recent winters have tended to have fewer Heating Degree Days (HDDs) than they did decades ago. This can be seen in the difference between the 10yr Normal and 30yr Normal columns illustrated on the right- hand side of the 13-Jan-25 forecast below.

The January 2025 WDD Forecast

Natural Gas Weighted Heating Degree Days

(Change is from Friday’s forecast)

As a result, deviations in heating degree days above 30Y norm levels are not only rarer but much more significant on a percentage basis relative to recent expectations, given the lower baseline. This is shown on the left-hand side of the forecast above, with every region above the 30yr Normal and most 10-20% above the 10yr Normal.

The effect on the market and prices is even more pronounced if the forecasting agencies are significantly off in their early predictions. The forecast below is by the same agency but from 18-Dec-24, less than one month before. Most of the regions then were forecasted to be warmer than the 10yr Normal.

The January 2025 WDD Forecast

Natural Gas Weighted Heating Degree Days

(Change is from Tuesday’s forecast)

Natural Gas Futures Prices: November 30, 2024 – January 17, 2025

The recent 26% rally in the Feb25 Natural Gas contract was highly correlated to a weather forecast that was unexpectedly and repeatedly revised colder over that period.

While this had negative consequences for short spread strategies over that period, it has created significant opportunities for those strategies going forward.

Precious Metals: Gold futures are at an all-time high, as of the time of writing. While historically, Gold has had a very strong inverse relationship with US real rates, most of this move to record highs occurred while rates were high or rising. Quantix has highlighted previously that our internal models would show Gold to be several hundred dollars per oz. lower if that historical relationship still held true.

In other words, there are clearly other drivers behind this price appreciation. Morgan Stanley recently revised their gold pricing model to include “other factors” as well as real rates. One of the most significant other factors is increased central bank demand. Their updated model more closely aligns with Gold’s actual historical performance and Quantix also believes that this is a necessary adjustment to make going forward.

In previous letters, I have also discussed the de-dollarization of central bank reserve assets as a major driver of Gold demand but it bears re-emphasizing today given current US government policy. Central bank gold purchases increased in earnest after the “weaponization of the dollar” through Russian sanctions in 2022.

Goldman Sachs estimates that “central bank and other institutional purchases on the London OTC market surged fivefold” since that event (chart above). Nov-24 saw another big move up in Central Bank demand.

Stronger sanctions on Russian oil and potential tariffs further intensify the impetus to diversify away from USD and into Gold. This is reflected in the intentions of Central Banks: 81% of the central banks surveyed by the World Gold Council expect global central bank holdings to rise over the next 12 months, with 0% anticipating a decline.

Some argue that strong USD (which has risen 7% since the start of 4Q24) is a headwind for Gold demand. We would counter that this phenomenon is more relevant for non-US retail/jewelry demand than official sector purchases. Most central banks are just replacing US dollars that they already hold for Gold and therefore maintain the same purchasing power regardless of how weak their domestic currency may be.

Outlook

Despite relatively muted performance in broad commodity indices and spread strategies in 2024, we are excited for the performance potential of Quantix strategies in 2025.

We believe both our relative value and long-only strategies are well positioned to take advantage of a change in the market environment that we are already witnessing in the new year. The flexible and tactical active management of our investment process is designed to capitalize on changing market dynamics. We are focused on that part of the process and expect it to be a potential driver of returns this year.

Conversely, we would expect passive, non-actively managed products that are purely based on a now- obsolete market structure to struggle. Some of these products have seen very significant inflows over the past few years from non-commodity specialists and, as this massive amount of capital unwinds, there will likely be distortive moves and potential alpha that Quantix is poised to harvest.

For allocators focused less on uncorrelated alpha and more on the portfolio effects of strategic asset allocation, a commodity investment is arguably more critical than ever. There has been an incredible and rapid shift in the global political landscape. Trump’s first week has seen a flurry of activity and enormous disruption on multiple fronts. Potential tariffs are poised to come into effect imminently. Overtures toward Greenland and the Panama Canal that were once unthinkable and are now daily headlines. The key question is what can be done to protect portfolios from the inflationary potential of these geopolitical ructions. We believe that hard assets are the answer.

In addition, the concentration in markets (and particularly the US equity market) has been extensively covered and an increasing area of concern for investors. In contrast, Quantix estimates of commodity index length (approx. USD140bn between BCOM and SPGSCI as of the end of 2024) is no higher than in 2015 and investors have generally not made wholesale allocations back to commodities yet. For many of the reasons discussed in this letter, we expect that to change. The greater volatility and strong directional trend to commodity markets that we have witnessed in January is potentially foreshadowing a much more active commodity trading market in 2025.

Please reach out to Quantix to discuss how our strategies can help take advantage of this opportunistic environment and provide potential benefits for your investment portfolio.

Sincerely,

Don Casturo CIO, Quantix Commodities LP

Important Information

The views expressed herein are those of Quantix Commodities at the time the comments were made. These views are subject to change at any time based upon market or other conditions, and the author/s disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions are based on many factors, may not be relied upon as an indication of trading intent. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

Performance data shown represents past performance and is no guarantee of future results.

The Bloomberg Commodity Index (“BCOM”) is designed to be a highly liquid and diversified benchmark for commodity investments via futures contracts. The index listed is unmanaged and does not reflect fees and expenses and is not available for direct investment.

The BCOM Petroleum Subindex (BCOMPE) is a commodity group subindex of the BCOM composed of futures contracts on Petroleum.

The BCOM Petroleum Spot Price Index (BCOMPESP) is a specialized component of the BCOM that focuses exclusively on the spot prices of petroleum-related commodities.

The S&P GSCI (SPGSCI) is an index of 24 exchange-traded futures contracts that represent a large portion of the global commodities market.

Alpha is a measure of risk (beta)-adjusted return.

Uncorrelated Alpha refers to excess return that is independent of systematic risk (beta) and broader market movements.

Investing entails risks and there can be no assurance that any investment will achieve profits or avoid incurring losses. Stock markets are volatile and equity values can decline significantly in response to adverse issuer, political, regulatory, market and economic conditions.

Forecast and estimates are based on hypothetical assumptions and for informational purposes only.

References to specific company securities are for illustration only and should not be construed as an offer or solicitation from Harbor Capital to buy or sell any securities.

Commodities Risk – The value of commodities investments will generally be affected by overall market movements and factors specific to a particular industry or commodity including weather, embargoes, tariffs, or health, political, international and regulatory developments.

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