Unpopular and unloved; commodities are certainly displaying some of the characteristics seen in Japanese and European equities prior to the re-ratings they saw last year. But there are some crucial differences.
In much the same way that a European recovery was dependent on a show of union from the region’s power players and on the central bank stepping up as lender of last resort, the surge in Japan’s equity market relied on a concerted and cohesive effort from Prime Minister Shinzo Abe, which took the form of a ‘Three Arrow’ economic plan.
All eyes on China
When it comes to commodities there is one major systemic factor investors are watching like hawks – Chinese economic growth and the form it takes.
Incidentally in the third quarter of last year, Chinese GDP growth picked up for the first time since the final quarter of 2012, from 7.5% in the three months previously to 7.8% in the July-to-September period.
It is not enough for China to keep on growing at an annual rate of mid-to-late single digits. For commodities to rebound from their two-year bear market the second-largest economy on earth must continue to invest in infrastructure and industrial development.
For commodity producers there is big disappointment each time the Chinese authorities highlight intentions to shift to a consumer-led economy, or so commodities bears would have you believe.
Cycle slowdown
Goldman Sachs is one such bear and its argument centres round the theory of a commodities super-cycle, which it thinks has well and truly come to an end.
In a recent paper its analysts produced on mining companies and their share price performance, it said the cycle started in 2001 and continued until the end of 2011.
During the boom the Stoxx 600 Basic Resources Index (SXPP) outperformed the Stoxx Europe 600 Index by 22 times (it returned 177% vs 8% from the wider market).
“It was not hard to make money investing in the miners as China radically increased its demand for commodities such that the miners had no immediate response and prices increased over 500%,” the report read.
“This all changed in 2011 as commodity prices reversed their decade-long rise and the miners started to decline.”
Since the end of Q1 2011 the SXPP is down 38% compared with an 8% rise from the Stoxx Europe 600 Index, even once the recent strong rally is taken into account.
Gearing back up
The rebound in performance during the past few months signals for some that a turnaround has begun.
James Sutton, a member of the JP Morgan Asset Management natural resources team, says since bottoming in June the JP Morgan Natural Resources Fund was up 18% by the end of September, although it was still more than 50% off its highs in 2011.
This to him shows some sort of recovery is underway.
“Commodity prices are bottoming across the energy, precious and base metals sub-sectors in which we invest and this is encouraging generalist investors to reappraise the sector for the first time in two years,” he says.
He is under no illusion investors will suddenly become incredibly bullish on the sector after such a period of selling, but he does see them reversing their underweights.
“It is possible we have reached a maximum underweight among fund selectors and multi-managers, with more generalist multi-managers returning based on the attractive valuations on offer,” he adds.
New faces
Another factor working in favour of commodity-based equities is a change of management at the top of many of the majors.
Previously known for their poor allocation of capital, 20 of the largest firms in the sector have appointed new CEOs in the past couple of years, points out Martin Currie’s head of natural resources Duncan Goodwin.
His Global Resources Fund was launched in 2006 and has had a severe underweight in mining and oil and gas firms since 2011, around the end of the supposed super-cycle.
But back in April he started to reduce his underweight because he felt just as the market was starting to “give up” on these firms he was starting to see some genuine changes.
For example, FTSE 100-listed miner Rio Tinto replaced CEO Tom Albanese in January 2013 after it became clear the company would report full-year losses in February.
In the nine months since Sam Walsh’s accession, Rio Tinto halved exploration expenditure to $774m (€575m), from $1.5bn in the same period in 2012.
Since announcing its third quarter update Rio Tinto has seen a number of upgrades from London analysts in what Sutton terms the “start of a virtuous cycle”.
It is this sort of responsible management which appeals to income investors, who are eyeing the growing cash reserves Rio Tinto and its counterpart BHP Billiton have.
Haig Bathgate, CIO at wealth manager Turcan Connell, says these companies are being highlighted by fund managers as stocks that will do well even if there is no increase in the price of the underlying commodities.
“These are increasingly being treated as value stocks rather than growth plays and traditional income and value managers are sniffing around them,” Bathgate explains.
He uses the Liontrust Macro Income Fund to access these opportunities, but is not allocating directly to commodities.
Recent data appears to support the green shoots of a global economic recovery. But while momentum remains negative we are content not to own diversified commodities within our portfolios
MOUHAMMED CHOUKEIR
CIO, KLEINWORT BENSON
“We have used ETFs and ETCs when looking for direct commodity exposure in the past and it is a sensible way to do it, but the problem with a large number of these is that you are trading futures and in most cases are hit with roll costs.
“So you need to be really careful because unless the price spikes these costs will often mean you lose money.”
The last time Bathgate used a commodity ETF was when the oil price fell to around $40 per barrel in the middle of the credit crisis, which he felt was ridiculously cheap. But he warns it is not as simple to gain exposure to commodities via ETFs as investors might think.
He also thinks there are still contrarian opportunities in European equities, since domestic-focused companies have yet to witness the rise in share prices seen among multinational companies, and so still represent good value.
“Parts of the market are still very depressed, chiefly the non-exporting companies in Europe, which are not benefiting from the Asian consumption story. We are not pessimistic on the outlook of exporting companies but they are not cheap anymore.”
A fine balance
Barclays Wealth & Investment Management also thinks there are better risk-adjusted prospects in other asset classes, so its tactical asset allocation committee moved to an underweight position in commodities last July.
Tanya Joyce, commodities strategist at the firm, says the challenge for commodities firms is as much about oversupply as it is about Chinese demand.
“These two factors will likely weaken market balances, which means the probability of a long-term substantial rally across the commodities complex is quite low in our view,” she says.
But she does point to variation within the sector: “Oil fundamentals remain constructive and we expect prices to remain underpinned by a tight supply/demand balance. Precious metals appear to have the weakest prospects.
“As monetary policy normalises, demand for perceived safe havens such as gold will weaken, which should cause prices to trend lower. The outlook for the industrial metals sub-sector also looks quite fragile as the slowdown in demand and growth in supply will leave many markets in surplus.”
Barclays’ tactical asset allocation committee has put the funds gained from the underweight call in commodities into an already overweight position in developed stocks, because it thinks they are still inexpensive despite the rally.
It has also bolstered its cash reserves and short maturity bond holdings, while investment grade credit and high yield fixed income are both held in underweight quantities.
Caution continues
Kleinwort Benson’s chief investment officer, Mouhammed Choukeir, sums up the dilemma surrounding commodities: “Using the Dow Jones UBS Commodity Total Return Index as our benchmark, diversified commodities rose 2.1% in the third quarter.
“These gains offset some of the losses sustained in the first half of the year. Yet the index remains some 8.6% down since the start of the year.
“Recent data appears to support the green shoots of a global economic recovery. But while momentum remains negative we are content not to own diversified commodities within our portfolios,” he concludes.
There is a danger, of course, that by the time momentum swings round allocating to commodities will have become a consensus call. Either way, it is not a call for the faint-hearted.
