Themes.

Updated quarterly, our evolving views on the thematics shaping the markets around us

Commodities

WHY IT MATTERS | Commodities are a fundamental piece of the economic machine, and its prices fluctuate in cycles with macroeconomic developments (population growth, industrial production, etc.) as well as technological innovations (which increases or decreases the demand for a certain commodity). Understanding which part of the cycle we’re in is a key factor for assessing potential investment opportunities.

THE TAKEAWAY | Obsessions surrounding ‘software eating the world’ and ‘green’ energy transitions have led commodities-related sectors to be abandoned by investors. This level of disregard relative to an entire asset class that remains crucial to financial markets and the overall economy has generally led to outsized returns in the following decades (stocks and bonds in the late ‘70s, gold in the late ‘90s). With current prices at all-time lows and the reflation narrative gaining traction, we might be at the beginning of a long-term bull cycle in commodity prices, which would imply structural long-term investment opportunities for investors.

 

OUTLOOK

  • Commodities are generationally cheap when compared to equity markets.

  • In the ‘80s, the energy sector was the largest component of the S&P500 with a 30% weighting, whilst today it stands just above 2% (Exxon, the oldest member of the Dow Jones, was removed from the index last year). Despite that, oil remains the most important input for global economic growth.

  • With an ever-increasing demand, mainly coming from Emerging Markets (China’s oil demand increased in 2020 despite the pandemic), and a tighter supply on the back of years of under-investment – rig count is down +70% since the peak in February 2012 and global upstream (i.e. pulling oil out of the ground) CapEx is down almost 50% – oil looks like an attractive investment proposition for those who are looking for ‘value’

  • Usually referred to as ‘Doctor Copper’ due to its historical ability to predict turning points of the economic cycle, copper has long-term structural tailwinds that are worth the attention of investors given it is a vital commodity for general economic growth as well as for the green energy transition. Most of it is produced in Chile and Peru and shipped to China, which consumes more than half of the world’s copper. About 62% of it is used in electrical wires given that it has the highest electrical conductivity of all the metals besides gold and silver, EVs use 4x the amount of copper as regular vehicles, and it is infinitely recyclable (it is estimated that since 1900, two-thirds of the 550 million tonnes of copper mined is still in productive use). According to Bernstein Research, global copper production would need to rise by between 3% and 6% per annum by 2030 for countries to meet the targets of the Paris Agreement on climate change. In the absence of a supply increase, this could create a supply shortfall that is poised to have a material impact on prices.

 

KEY IDEAS TO FOLLOW

Inflation | Whilst no other commodity has been as successful as gold at preserving value over time, commodities like silver, copper and even oil are considered inflation-hedge assets given their prices rise as inflation accelerates. Increasing inflation expectations (as we saw towards the end of 2020) should lead capital to flow into commodities.

US Dollar | Commodities trading is primarily facilitated in US Dollars. Therefore, the further the US Dollar declines, the cheaper it becomes for non-US Dollar based economies to buy them, increasing the magnitude of demand for these commodities.

Supply | Is primarily determined by the CapEx budgets of companies and governments around the world, with several years of lag between investment and production coming online. Of course, some commodities have a quicker reaction function and can adjust better to the varying level of demand (shale oil and gas, for example), but CapEx budgets should still help financial markets participants assess the future capacity of production of a country or company.

Demand | Is primarily determined by broader economic growth indicators, such as population growth, industrial production or new infrastructure being built. OECD countries account for 40% of total energy consumption and have broadly registered no growth in consumption over the last decade; non-OECD countries represent 60% of global energy consumption and they’re the main driver of increased energy demand – they’ve grown at 3% per year over the 2008-18 period.

Share of Renewables | The IEA forecasts renewable energy will account for 38% of total energy generation by 2050, up from 19% today, 46% of which will be solar and 33% will be wind. The growth of renewables will mainly come at the expenses of coal and nuclear energy.