The fall in the price of many commodities has rarely been far from the financial headlines this year after it led to fears of slowing global growth and trouble for the mining-heavy FTSE 100, but does this slump mean there’s a new area of value or is it still a distressed sector to be avoided at all costs?
Energy, agriculturals, industrial metals and precious metals – the four main commodity sub-groupings – have seen prices fall across the course of 2015, adding to the deflationary trend being seen in many parts of the globe and sparking concern in markets.
Of course, commodity prices have generally been heading down over recent years – leading to share price falls in the companies whose fortunes rely on them. While commodity producers such as miners surged in the commodity ‘supercycle’ of 2000s, they have faced a much more difficult time of late.
Performance of indices over 5yrs
Source: FE Analytics
However, some analysts are starting to call an end to plunging commodities prices and expect them to rebound from here on.
The team at macroeconomic forecasting consultancy Capital Economics notes that all four commodity sub-groupings have had a decent start to the fourth quarter, albeit after a very poor six-month run previously.
They add that “the good news is that this should be as bad as it gets” and argue that there are three main reasons to expect the price of most commodity to enter an upward trajectory for the next few years.
“First, the responses of producers to the previous slump in prices will start to constrain supply. The pace at which this will happen will vary – probably much sooner, for example, in the case of crude oil than iron ore where there is still ample low-cost supply. But the old adage that ‘the best cure for low prices is low prices’ still holds true,” the analysts explained.
“Second, markets have become too pessimistic about the outlook for demand. We expect the economic news from China in particular to improve over the remainder of the year and into 2016. Third, investor sentiment towards commodities is starting to bottom out. Indeed, compared to high-priced equities and bonds, many commodities now look attractively valued.”
When it comes to this final point, some professional investors are keeping a keen eye on the sector and some have started to buy into the space on the back of the attractive valuations on offer.
Schroders multi-manager Marcus Brookes, for example, recently started adding to commodities and emerging market funds, although he made relatively small moves back into both areas.
Mark Harris, head of multi-asset at City Financial, is another manager who thinks there could be a tactical investment opportunity in these areas that could yield “significant rewards”. When it comes to commodities, he says any weakness in the dollar – which has been strong recently and harming commodities – would be catalyst for a rebound.
Performance of indices over 2yrs
Source: FE Analytics
Harris said: “Looking forward, we expect US dollar strength will reverse into a trend change of dollar weakness in the last quarter of 2015. The long US dollar is one of the most crowded trades in markets with any unwind likely to be violent and sustained.”
“With nominal rates falling, lots of evident political issues, market shocks and high levels of pessimism, the longer term conditions have now turned decidedly more supportive for most commodities. As and when the US dollar starts to weaken, commodities should start to reward.”
But while some are turning more positive on commodities and the companies that produce them, others are more cautious about their outlook and warn that to buy them now could put investors at risk of being caught in a value trap.
Guy Stephens, managing director at Rowan Dartington Signature, points out that much of the blame for falling commodity prices has been placed at China’s door after a slowdown in the world’s second largest economy led to a fall in demand.
However, he argues that commodity producers are more at fault than many recognise as they ramped up supply because of higher prices and in the expectation that demand would continue to grow – but ended up creating a glut that is partly responsible for the low prices today.
“China has been vilified as the great pariah for distorting the global commodity market but in reality, the industry has geared itself up for a pricing environment which was unsustainable. This will continue to be the case whilst operators continue to forge their long-term plans based on the current short-term environment,” Stephens said.
“Today, it is difficult to see where any significant marginal demand will come from and we still have a glut of supply. It is very easy to blame the Chinese slowdown and the accuracy of their data releases but the reality of the commodities pricing environment is here and for now, it is very difficult to see why it should change for the foreseeable future.”
Colin McLean, managing director at SVM Asset Management, says the complex picture surrounding commodities means there is no set answer on whether investors should include them in their portfolios. However, he warns them to “beware the commodities trap” and not blindly assume they are a value opportunities just because of their recent falls.
“The appeal of commodities lies in their enduring permanent nature with steadily rising demand over time. More recently, burgeoning emerging market economies also promised ever greater demand. Commodities were promoted for their stability and widely deemed as an asset class that deserved a place in portfolios. The question that persists now for investors, is how best to navigate the sector,” he said.
“Metals and mining companies are disproportionately represented in the London stock market which feeds into the associated indices and index funds, such as ETFs. Given how closely many conventional actively-managed funds follow indices, the impact on portfolios has been significant. It is more essential than ever for investors to develop a real world understanding of risk rather than simply relying on the indices.”
“It is clear that not even the mining giants or their bankers are good forecasters of commodity prices and so investors should be dissuaded from such predictions. Instead they should consider how their portfolios are positioned in a deflationary world and then determine whether commodities balance risk or increase it.”
