Performance of FTSE All Share vs FTSE World Index -Mining
Source: Financial Express Analytics
The main factors at play are the rising demand due to the global changes in demographics, increasing prosperity in the emerging markets, and continuing urbanisation. On the supply side, many key commodities are finite, and there is a disproportionate increase in the marginal costs of production.
Promising long-term potential
With something of a time lag, we believe the credit crisis will strengthen the commodities super-cycle rather than slow it down. The reason for this lies in the global allocations of capital over the past years, which have tended to lead to high investments in the real estate and financial sectors and lower investment in areas such as infrastructure, energy and agriculture. As the economic recovery takes hold, this is likely to result in even greater demand for commodities and associated price fluctuations.
Not just dependent on commodity prices
Investors can participate in the commodities trend by investing directly in commodities, but they also have the option of investing in commodities stocks. The latter is an interesting alternative for several reasons.
Firstly, commodities companies profit from the attractive long-term outlook for the commodities markets. If the price of a commodity rises, this in principle has a positive impact on commodities firms from the respective sector, be it oil companies, mining companies, or agricultural producers. The potential earnings enable the firms to increase their capacities and search for further reserves.
These companies have the advantage that they are not solely dependent on price increases in the underlying commodities. There are other factors that drive their share prices, one of the most important being an increase in production volumes, which has a direct impact on turnover, results and the share price.
Hence, with disciplined capital expenditure and appropriate cost structures, commodities firms can still be in a position to increase their earnings when commodity prices are in a sideways trend or even when they are declining. This opens up the opportunity for commodities stocks to post excess returns relative to the underlying commodities over the long-term.
Dirk Kubisch is product specialist at Julius Baer Asset Management. The views expressed here are his own.