“Forecasting commodity prices is a mug’s game,” says The Economist. The magazine knows that better than most, having been “much mocked for [its] suggestion in 1999 that, in a world ‘drowning in oil’, a barrel of the stuff might cost as little as $5”. Crude prices subsequently peaked at nearly $150 per barrel in 2008. Yet today, “the world is again awash” and West Texas Intermediate crude prices even briefly went negative last month due to a shortage of storage space. “Analysts are asking again, as in 1999, if the world will have to get used to permanently low prices not just for oil but for other commodities too.”
As cheap as they’ve ever been
If this kind of sentiment doesn’t make you want to invest in natural resources, it’s hard to know what would, say Lucas White and Jeremy Grantham of asset manager GMO. Consider how this same cycle has played out over the last few decades. During the 1980s and 1990s, commodity prices fell and producers cut back on investment, “leaving commodity markets unprepared to meet the China-led boom in commodity demand that started in earnest in the early 2000s”. The result was supply shortages and soaring prices – not just for oil but for metals as well.
Inevitably that drove a surge in capital expenditure by producers, which meant “new commodity supply flooded the market” in the 2010s. Prices dropped 18% on average over the next decade; oil fell twice as much. By the end of last year, the cycle had run its course to the point where resources “very well positioned to rebound after a tough decade”.
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Then the coronavirus crisis hit. Commodity prices slid, as did the shares in the resources sector, making cheap assets even cheaper. At present, energy and metals firms are valued at a discount of almost 80% to the S&P 500, against a long-term average of around 20%. “Over the last 100 years or so, we have never seen resource companies trading at anything close to these levels relative to the broader market.”
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Balancing supply and demand
We can’t expect commodity prices to rebound as fast as they did after the global financial crisis in 2007-2009, says Paul Robinson of consultancy CRU Group in the Financial Times. The sector is unlikely to see the same appetite for raw materials that resulted from China’s infrastructure stimulus back then. That implies a slower recovery in demand this time.
Still, “margins remain positive for most mining assets”, while companies have manageable levels of debt. This puts them in a resilient position. So long as miners maintain “supply discipline” – ie, avoid glutting the market at a time when demand is uncertain – “commodity, share and related debt prices could all outperform in the weeks and months ahead”.
