Is the commodities super-cycle over? Few questions are more important for the Australian economy or share investors. If key commodities such as iron ore and coal have bottomed, resource stocks could be the contrarian buy of the decade, given huge share-price falls in the past year.
ETF Securities (ETFS), predictably, believes the commodity super-cycle is far from dead. With US$23.2 billion in assets under management (at June 30, 2013), ETFS has much to gain from a metals rebound and higher demand for its commodity exchange-traded products (ETP). That said, ETFS’ insight into fund flows gives it unique perspective on how the smart money sees commodities.
In its Global Commodity ETQ Quarterly Report released this week, ETFS said: “Both the fall in the gold price and investor selling of gold ETPs is overdone.” On cyclical metals, it said supply constraints for platinum, palladium and copper were becoming more price-supportive. “If China’s growth fears are temporary, these metals will likely perform again and investor flows will likely follow.”
A short-term bounce in commodities would not surprise. The question is whether gains can be sustained in the medium term. ETFS believes the key drivers of the commodity super-cycle – resource-intensive urbanisation and industrialisation in large-population emerging markets – still have a long way to run. Rising per-capita incomes in stgeloping nations will drive huge commodities demand this decade.
ETFS said: “Most recent arguments for the death of the commodity super-cycle are focused on the short term (one to two years) outlook for a few specific commodities. This is very different from providing evidence of a long-term (10 years) structural price decline across all commodities.”
It added: “Even if the emerging-market economies grow at a slower rate over the next decade, the absolute demand for commodities is likely to grow as these large-population countries get richer … and the supply of many commodities is likely to remain constrained.”
I’m not nearly as bullish on commodities as ETFS. Its demand-side arguments, based on a continued population growth, urbanisation and a bigger middle-class in Asia, make sense. But higher supply could drive commodity prices lower and stymie any recovery.
The only certainty is that commodity prices have a habit of smashing market expectations on the way up – and on the way down. Put another way, historically they rise much further than people expect and fall to levels that seem almost unthinkable, for longer than expected.
I can’t see the commodity super-cycle turning higher anytime soon, and believe there is too much risk to chase resource stocks (perhaps with the exception of BHP Billiton and Rio Tinto), mining-service companies, or commodity ETPs.
AMP Capital Investors chief economist Shane Oliver put it succinctly in a research note this week: “The time for large exposure to commodities has passed … Commodity prices appear to have peaked under the influence of slowing Chinese growth and increasing supply.”
Dr Oliver made a similar argument to one this column has presented in recent weeks: stick to stgeloped-market equities and avoid emerging markets.
As Dr Oliver notes, the US economy is gradually mending as its housing sector recovers and the shale oil and gas boom lowers energy prices. Japan is awakening after a 20-year slump and the Eurozone appears to be gradually emerging from a crisis over its existence, with peripheral countries adopting economic reforms.
“This is occurring at a time when the emerging world is looking a little less bright,” Dr Oliver wrote. He says risks to the Chinese economy have increased after several years of rapid debt growth; India, Brazil and Indonesia have a less attractive growth/inflation trade-off; and South America and Russia are vulnerable to a less favourable commodity-price outlook.
What does this mean for investors? First, stick to the equity markets of stgeloped economies such as the US, which remains the standout investment idea despite strong gains in its key sharemarkets. Japan is also attractive and even Europe is emerging as a higher-risk contrarian idea.
Second, avoid the temptation to increase portfolio asset weightings towards emerging economies. Don’t believe that emerging-economy equities will star again this decade – as they did in the previous decade – and outperform stgeloped-nation equities. That trend is reversing.
Third, take great care with resource stocks. Although the sector looks cheap, there is too much commodity-price uncertainty to dive in. Mining-services companies look cheap if one believes their earnings will hold up, but the evidence points to further profit downgrades.
Fourth, expect the Australian dollar’s descent to continue. As growth in emerging economies eases, commodity prices will fall further, bringing commodity currencies such the Australian dollar down with them. An Australian dollar at US85 cents by year’s end looks a better bet by the day.
This column’s core idea for 2013 – buying US equities in unhedged currency terms (to profit from the weaker Australian dollar) remains firmly intact. Yes, there will be inevitable pullbacks and corrections in US equities along the way, but the medium-term outlook appeals.
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Jul 17, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.