Anyone thinking about buying back into the commodities sector should look at oil producers, as a quick rally in the price of the fuel will quickly translate into a rise in share prices.
This is according to FE Alpha Manager Alex Wright, who runs the Fidelity Special Situations fund and Fidelity Special Values trust.
However, the manager is far less optimistic about the prospect for mining stocks, pointing out they will not benefit in the same way from a positive change in the price of the materials they extract.
“Looking at the mining sector today, I see limited evidence of positive change, and I expect the environment to remain challenging for most large mining companies,” he explained.
Performance of sectors over 5yrs
Source: FE Analytics
“In oil, however, I see a different set of industry dynamics with some positive change already occurring – making the sector a better source of investment ideas for the funds under my management.”
The manager points out that oil production requires significant ongoing investment (on average, oil wells need approximately 7 per cent invested every year to maintain production), which means it tends to be more responsive to falls in demand.
“Some projects can quickly become unprofitable and capital leaves the sector,” he explained.
“We have already seen decreases in shale production and our forecasts indicate year-on-year production could fall as soon as the end of this year.”
“As supply falls, spot prices can recover, meaning the remaining operators with high quality (low cost) assets become more profitable.”
“Additionally, lower oil prices have themselves increased demand from the US, Europe and even in China, whereas falling metals prices have had little impact on metals demand so far.”
“The positions I have in this sector are in companies with solid balance sheets and low production costs, as I am more comfortable that downside will be limited if prices don’t recover quickly.”
“I have over 6 per cent in a combined BG and Shell position, as I believe this deal will complete, and that the new business it creates will be a much stronger one, with improved free cash flow and strategic positioning in LNG.”
While 9 per cent of the Fidelity Special Situations fund is invested in in oil and gas producers, he has only 1.5 per cent in mining companies (with no FTSE 100 groups found in this exposure). 
Wright (pictured) says supply-side analysis can explain the reason for the difference in positioning between the two sectors.
“The majority of capex in mining projects occurs before production actually starts,” he said.
“In key metals, such as iron ore, the incremental costs of producing are fairly low once the mine is operational. This means production remains profitable and thus continues even as demand and spot prices fall.”
“It can also take a number of years to bring a mine into production. This means supply increases today are the result of investment decisions made by mining companies many years ago, when spot prices were much higher.”
“Our in-house metals analyst models global supply based on his interactions with company management and other industry participants. According to this analysis, it is still likely to be several years before we see year-on-year falls in iron ore production.”
“Therefore, any improvement in spot prices requires an increase in demand beyond the extra production.”
Wright has begun to see a different culture emerging at mining companies, with a more disciplined approach to capital allocation. However, he says that while the sector may look attractive at some stage, positive change is too far away at the moment to drive performance over the next year or two.
However, not everyone is as negative about miners as Wright. BlackRock’s head of European equities, Nigel Bolton, says the correction over summer was excessive.
Meanwhile, IG senior market analyst Alastair McCaig thinks conditions could soon become more favourable for commodities.
“The mining industry has been battered and bruised recently, but the possibility of an easing policy from China has seen the buyers flood back in again,” he said.
“The bounce that we have seen in commodity prices over the past week has continued to hold. These more encouraging levels have seen the energy and mining-heavy FTSE show the sort of resilience required to ensure the normally investor-friendly fourth quarter of the year holds true to form.”
FE Analytics data shows Fidelity Special Situations has made 6.29 per cent since Wright took over at the start of 2014, compared with 5.01 per cent from the IA UK All Companies sector and 2.78 per cent from the FTSE All Share.
Performance of fund vs sector and index over Wright’s tenure
Source: FE Analytics
The fund’s top holdings is HSBC, followed by Lloyds, Citigroup, Sanofi and Regus. BG Group is his sixth biggest holding with an overweight 3.2 per cent weighting, while Royal Dutch Shell is next at 3.1 per cent.
The £2.7bn Fidelity Special Situations fund has ongoing charges of 1.16 per cent.
