A string of great quarterly reports for London-listed miners this week has sparked a sector rally that has today driven the FTSE 100 index to its highest level in over two months. The rally was led by the Australian mining goliath BHP reporting a record half-year profit. The company, which is headquartered and listed in Australia after abandoning its dual listing in London early this year, is the world’s biggest coal miner and is to pay a record $16 billion annual dividend after profits were bolstered by surging coal prices.
However, the spectacular $23.8 billion profit being generated by BHP for the year to the end of June was thanks to high coal prices but prompted investors to drive up share prices across the wider resources sector. FTSE 100 constituents Glencore, Anglo American and Rio Tinto are up 3.65%, 3.1% and 4% respectively today.
Their gains have lifted the FTSE 100 27.05 points to 7,536.20 point, its highest level since late June. The benchmark index has now returned gains in 6 of the last 7 sessions and is up 4.3% over the past month.
Several months ago we suggested investors should look at the mining sector as commodity prices soared and a number of prominent analysts forecast a new commodities “supercycle” lasting years. However, while commodity prices maintained a strong upwards trend between late last year and June, they’ve since softened.
Source: The Globe and Mail
The share prices of most miners, Glencore which makes much of its revenue from commodities trading rather than mining is an exception with a gain of 47% in the past 12 months, have also softened.
Did we get it wrong on the mining sector early this year when the hope was the beginning of a commodities supercycle would keep prices high for years to come, benefitting miners?
Why have commodity prices fallen since June taking miner share prices with them?
BHP’s record half year profit announced today was driven by coal prices. The miner is also a huge producer of iron ore, the price of which has dropped but was compensated for by coal revenues.
Source: Trading Economics
Earlier in the year Russia’s invasion of Ukraine threatened to drive the prices of many commodities to record levels. However, fears of a recession, and the impact that would have on demand, has since seen them ease. BHP today said it expects the market for its main commodities to remain volatile for the foreseeable future. However, the miner expects demand from China to offset slow growth across advanced economies:
“Growth momentum has slowed across many key regions, and caution remains due to geopolitical uncertainty as well as Covid-19. This is particularly evident in advanced economies, as central banks pursue anti-inflationary policy and Europe’s energy crisis is an additional source of concern.”
However, Beijing is cutting interest rates and plans major infrastructure investments as it attempts to stimulate an economy hit by Covid lockdowns and a crisis in its real estate sector. That should underpin demand for commodities used in construction.
Why are analysts forecasting a commodities supercycle and see recent price drops as a blip?
One of the main arguments put forward by analysts who think we have just seen the first leg of a new commodities cycle and prices will rise again is underinvestment by miners over the last decade.
Jeff Currie, head of global commodities research at Goldman Sachs highlights that despite the rotation of capital out of tech and into energy and other commodities like metals, there hasn’t been a big influx of capital into the sector. He notes “the only money that is really coming into this space is share buybacks”.
Based on that he asks and answers the question “are you too late in this space?”, with “absolutely not, it’s just beginning”.
Currie also makes the point that while energy and commodities companies account for just 5% of the S&P 500’s market capitalisation, the sector generates 9% of the benchmark index’s revenues. This, he believes, shows the sector is still under-invested in, adding “it’s a huge capital misallocation that is occurring”, across “the entire old economy”.
The bottleneck to miners and other “old economy” producers that need to increase their production after a decade or more of underinvestment is current levels of commodity price volatility. An answer to the “volatility trap” caused by underinvestment would be higher returns convincing investors to allocate capital to the space. Over recent history, the commodities sector has offered relatively poor returns compared to growth sectors like tech.
Currie believes the commodities space needs a three year track record of generating returns high enough to compensate for volatility and a recent history of poor returns to attract significant new investment capital. And that we are currently just 18 months into the sector generating the higher returns investors are looking for.
James Luke, a commodities specialist at Schroders, is also of the opinion we are currently “in the early stages of a multi-year cycle”. He expects the cycle to be driven by demand from China once its government has driven its economy out of the other side of its Covid-19 pandemic slowdown.
But what about industrial metals like iron ore, aluminium, copper, tin and zinc? Over the past 18 months, industrial metals, like energy commodities, have outperformed equities after a decade or so of disappointing returns. In a recent podcast, PNB Paribas’s global chief investment officer Edmund Shing discusses the impact of the transition to a low carbon economy on demand for industrial metals.
He also points out how low industrial metal inventories have recently dropped with underinvestment by miners in new capacity over the past decade again pointed to as the root cause of the supply issues that have pushed prices up in recent months. The bank’s experts expect demand for base metals to outstrip supply over coming years even if recession in the West temporarily dampens it. The bank also believes China will invest in infrastructure as a lever to return economic growth.
The bank thinks some exposure to commodities, especially through liquid vehicles like ETFs, makes sense for all investors over the next few years as one of the best hedges against inflation and currency devaluation. Its experts see copper, aluminium and the battery metals lithium, nickel, cobalt and graphite, as well as platinum (increasingly used as a substitute for palladium in the automobile industry), as the metals most likely to see high prices maintained for years to come.
That would make miners with significant exposure to these metals also potentially attractive for investors, especially as they currently look cheap and often pay good dividends which tend to rise when commodity prices do, generating excess profits.
Despite the likelihood of volatility in metals prices over the short term, BNP Paribas believes there is much more potential upside for metals over the medium term than downside.
A recent report by the German investment bank Berenberg also notes on industrial metals “lack of investment in recent years limits the potential for supply expansion” and “structurally rising demand coupled with a lack of capacity on the supply side results in rising prices in the long term”.
Source: Berenberg
While periods of more intense industrialisation, particularly of China over the past two decades, have triggered historical commodities supercycles, Berenberg also believes the process of decarbonising the global economy will drive the one that has now started.
Source: Berenberg
The Berenberg report, published in August, concludes:
“Industrial metals have suffered badly in recent months from recession worries in
the West and the lockdowns in China. The demand outlook for the coming months
remains highly uncertain. However, industrial metals have now largely priced in this
uncertainty. We think that the long-term upside potential – driven by the strong
growth in demand from green technologies and the reluctance of producers to
invest – should be unaffected by all this. On the contrary, the longer-term trends
may even have accelerated as a result of current developments. In our view, this
offers a favourable opportunity to join the super-cycle of industrial metals.”
Miners and industrial metals ETFs offer a shorter term inflation hedge and mid to long-term growth potential
In the near term, an investment in miners with high exposure to industrial metals miners, or ETFs and ETCs that hold these metals directly, is one of the most obvious investors can hedge against inflation and currency debasement. Longer term, the commodities and metals supercycle many analysts predict could also see miners reverse over a decade of poor returns and enter a new growth phase.
