Commodities have been in the doghouse for much of the last decade. The largest and best-performing specialist natural resources fund in this sector, BlackRock World Mining, has lost 11% of its net asset value (NAV) over the last ten years, although its share price does show a small positive gain. Commodity specialist Goehring & Rozencwajg notes that raw materials haven’t been this cheap compared to US equities since 1920.
Yet there are now signs of an incipient recovery as investors look forward to a global rebound in 2021, when demand for materials and energy products should improve. Iron-ore spot prices gained 33% between 1 January and mid-November; palladium 21%, uranium 19%, and copper 15%. Oil, despite a bounce to $50 a barrel in recent weeks, is still down by 34%, while platinum is down 6%.
Keep an eye on the greenback
Fluctuations in the value of the dollar have an impact on commodities too. Most are priced in dollars, so they tend to rise when the dollar weakens (this makes them more affordable for holders of other currencies) and vice versa.
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A rising dollar is often a reflection of a global flight from risk, which implies concern over an economic downturn. As investment boutique Ocean Wall points out, “heavy fiscal stimulus and expansionary monetary policy could see the dollar’s position erode... in 2021, creating a positive feedback loop similar to what happened in the 1970s and 2000s when commodities reached historical highs.”
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Lurking in the background is a possible long-term tailwind: the rise of inflation as the recovery picks up speed. Inflation bodes well for raw materials. As overall demand climbs, prices rise, putting upward pressure on the cost of raw materials needed to produce goods. It also takes a relatively long time to increase the supply of most commodities, so demand often eclipses supply in good times.
The most articulate explanation of what might happen came in a recent widely circulated note from Vincent Deluard, global macro strategist at America’s StoneX. In his latest global macro report, he surmises that inflation will be driven much higher by wages and bank credit, which are “finally rising”. The pandemic diverted consumption towards digital goods, which have no marginal cost, but the vaccine will redirect pent-up demand towards “real things”, which face physical constraints.
Yet it’s also important to sound a note of caution in the short term, as commodity prices tend to move erratically. The state of the energy markets shows how commodities can take their time to rebound. Guinness Asset Management argues that the path to higher oil demand might be uneven and vary by region, with much of the developing world still struggling with Covid-19 even in 2021.
As far as industrial metals are concerned, however, the outlook is arguably much brighter. Analysts at investment bank Goldman Sachs note that copper inventories in China have declined significantly.
They reckon that “peak... copper mine supply is fast approaching on the horizon (end of 2023) and is now closer than at any point in the last 20 years. This means the ten-year supply shortfall is now at a record level for copper”.
Smaller metals join the party
Uranium prices, meanwhile, have bounced aggressively while many metals associated with batteries are doing the same. The share prices of lithium producers in Australia have performed strongly as the market started to get excited about the outlook for lithium. Lithium-ion batteries are the key component in electric vehicles.
How investors play all these cross-cutting themes is vital. Many individual commodities can be tracked through individual exchange-traded funds (ETFs). But this is a risky and volatile way of capturing any upward trend – if you’re unlucky your chosen commodity could buck the trend. Nevertheless, I think copper and metals related to the new-energy sector will probably do best.
In terms of actively managed funds, that implies a focus on Geiger Counter (LSE:GCL) or Yellow Cake (Aim: YCA) – both of which invest in uranium – or on a battery-focused fund. In the broader mining sector, the standout fund is the BlackRock World Mining fund (LSE: BRWM), where managers Evy Hambro and Olivia Markham make lots of active decisions about which mining stocks to back.
It offers a useful yield of around 4.5% but it is also heavily exposed to precious metals (including the platinum metals), which account for just under 40% of holdings. Precious metal prices have their own unique dynamic. They tend to fall back in a cyclical recoveries but then rise as inflation starts to spiral.
Another option is the Baker Steel Resources Trust (LSE: BSRT). It concentrates on smaller and mid-cap businesses as well as private companies, all of which should outperform the bigger outfits in a recovery.
That said, its discount is tight at only 5% and it also doesn’t pay a yield. I am also wary of its near-40% exposure to precious metals. The CQS Natural Resources Growth and Income fund (LSE: CYN) pays out a hefty 5%-plus yield and also trades at a big 18% discount to NAV.
The fund is also more focused on mid to small-cap equities than BlackRock World Mining and thus might be more highly geared to a cyclical upswing but, again, precious metals are a hefty, circa 30%, exposure in the portfolio.
