Commodity markets are hugely volatile as sentiment switches back and forth from optimism about a recovery to fears of a double dip recession. As each new set of data points one way or the other, prices of copper, aluminum and other key metals fluctuate accordingly.
However, the big challenges, the sovereign debt crises and lacklustre growth, have both taken a turn for the worse. Economic growth, for example, has faltered as the huge government stimulus projects and loose monetary policy that had helped spur industrial restocking last year, draw to a close. Metals such as copper and aluminum have fallen by about 20 per cent since the start of April while mining stocks such as BHP Billiton and Rio Tinto, which had been in favour in the initial post-Lehman recovery, have fallen by similar amounts.
Fund managers are split on whether China’s growth will slow in the second half. The Chinese Government has tightened monetary policy to keep the lid on inflation, while its $580bn (€474bn) stimulus package is coming to an end.
David Field, commodities portfolio manager at Carmignac Gestion, is currently overweight gold at 30 per cent, largely reflecting difficulties in Europe, but he does not anticipate a double dip in global growth.
Emerging market growth
“We are still getting good signals on inventories from China,” says Mr Field. “For the first time in eight to nine months, copper stocks are consistently falling. Copper is the bellwether of base metals, the best indicator of industrial growth, while in comparison for example nickel’s price can be influenced by purchases of small amounts of inventory. So physical demand indicators are good and I am confident in the outlook for the next 12-18 months,” he adds.
“Long-term trends in emerging markets are extremely supportive,” says Mr Field. “We saw above trend growth and prices in commodities for a long period in the 1960s owing to Japan industrialisation, but China is much bigger than Japan ever was and should support prices for longer. This considerable growth is based on the urbanisation and modernisation of China but following on behind are India, Indonesia, Brazil and Argentina, and Russia as well, so this is very comforting for the long-term.”
Others make a comparison with the 30-year cycle to rebuild Europe at the end of the First World War.
Fund managers are most bullish about bulk commodities such as iron ore, coking coal, and copper, which looks well supported, and least bullish about aluminium, because there is already significant capacity, and steel, because China has boosted its capacity and some of that steel could end up in export markets.
Mr Field points out that iron ore producers have a very strong bargaining position. Some 75-80 per cent of the seaborne iron ore trade is concentrated in the hands of just five players. Three players, Rio, BHP and Vale Operations in Brazil, control 65-70 per cent of the market and are implementing big price hikes.
However, steel prices have fallen for seven consecutive weeks as the more fragmented steel industry faces a slump in demand for its finished product. The China Iron and Steel Association has warned that steel production will fall in the second half. Both miners and steel producers could face a further wave of downgrades once this impasse is factored into their long-term forecasts.
“The fundamentals are still strong but we’re going through significant macro-economic headwinds, which are affecting the valuation of equities but are outside of their control,” insists Evy Hambro, joint chief investment officer at BlackRock. “These companies are trading on valuations that do not reflect their underlying profitability. Prices of gold, platinum and copper are up, yet share prices do not reflect this and there are surprising extremities in valuations.”
One headwind is the proposed 40 per cent Australian super tax on the profits that miners make from their Australian assets, which has frustrated big mining groups whose high margin, old assets would take the biggest hit.
Companies in profit
Mr Hambro takes comfort, however, from falling inventories, which have come down quite substantially after the de-stocking two years ago. Copper for example peaked at 18 February but its inventory is down 16 per cent (or 100,000 tonnes) since then.
“One of the most visible indicators of the demand is the premium paid for immediate delivery of metals such as stainless steel or aluminium,” he says. “The profits these companies are making are real, and their balance sheets are now very conservative, so we’ve been surprised to see such volatility.” Evidence suggests investors are taking advantage of the current sell off.
Joanne Warner, fund manager of the First State Global Resources fund, agrees there is value in traditional mining names, such as Xstrata, which have taken a beating in recent weeks. “Stocks are currently pricing in significant falls in commodity prices, making these valuations particularly attractive on a three to five year basis,” she says.
