ETF Securities, a London-headquartered provider of exchange-traded products, has published its market outlook for 2016, containing a mix of consensus and contrarian calls. Among them is the forecast that the US dollar is set to weaken and that supply side destruction is emerging in the commodities space.

James Butterfill, Head of Research and Investment Strategy at ETF Securities.

The bearish position on the greenback is perhaps the biggest call.

With the Federal Reserve (Fed) expected to commence raising interest rates, ETF Securities goes against consensus, predicting the US dollar to begin to decline in Q1 2016, citing historical evidence that shows the currency has traditionally weakened at the beginning of a tightening cycle occurring after an extended period of low rates. Furthermore, although asset prices appear to be nearing their peak fundamental valuations, as is expected before a rate hike, the paper suggests this cycle may not follow a conventional trajectory.

James Butterfill, Head of Research and Investment Strategy at ETF Securities, commented: “US official policy interest rates are going to rise; however, the Federal Reserve balance sheet has never been this vast and so most asset classes will be entering unchartered waters during this tightening cycle. ETF Securities’ analysis of previous Fed hiking cycles suggests, contrary to popular belief, that there could be a US dollar sell-off.”

Concerning equities, following normalisation of interest rates by the Fed, ETF Securities predicts international equity exposures to outperform US stocks and emerging markets to exhibit moderate growth, although factors such as a Chinese hard landing, the extent of structural reform in key economies, foreign exchange disruptions, including currency wars, and commodity prices may all serve to distort this forecast.

Turning to fixed income markets, ETF Securities stresses that US Treasuries appear to be in bubble territory and are due to depreciate; however, the extensive use of government bonds as a policy tool continues to muddy the waters here. Historically, yields have risen by 1% in the 12 months following an initial rate increase but under similar conditions in 1994 yields rose by 280 basis points in a year. Investors are advised to seek a balance between ETFs with opportunities for enhanced returns and managing the duration risk of their portfolios.

On the commodities front, the outlook notes the significant capital expenditure cuts being made by producers across the commodity spectrum. ETF Securities suggests that continual low commodity prices may spur producers to ramp up the pace of expenditure cuts. Consequently, the firm believes the extended period of oversupply will soon be coming to an end. And with investor sentiment currently so weak, any shift in positioning may induce a rebound in commodity prices.

Regardless of the short and medium-term outlook, however, ETF Securities reiterates the long-term case for maintaining an exposure to commodities, with its analysis suggesting that the risk/return profile of a portfolio is enhanced with a 10% allocation to commodities. Interestingly, investors may achieve these benefits regardless of whether the portfolio strategy is cautious, balanced, or growth-oriented.

The outlook also makes the case for gold, identifying the increased risk of policy error. ETF Securities makes the point that central bank policymakers are not infallible and even suggests the Fed missed a beat by not increasing rates in September. Disruptions to the equilibrium, coupled with mis-timing by the Fed, may lead to a surge in inflation which has historically caused gold to rally. For this reason, investors may wish to hold gold within their portfolio.