Commodity-related investments have unquestionably been an unloved and challenged area of the market over the last few years. The Morningstar Commodities-Broad basket category has fallen by more than 10% so far into 2014, making it the lowest returning asset class this year. Even more dramatically, the category is headed for its fourth annual decline. Many commodities prices have collapsed dramatically in the last year and some, such as iron ore, are touching rock bottom prices, causing a renewed criticism of the sector.
Commodities and resource equities have come under pressure for a number of reasons. Concerns around the sustainable level of global economic growth coupled with increased supply in key commodities and political unrest have all largely contributed to a poor backdrop for the sector. This weak trend has been exacerbated, to a large extent, by the slowdown in China. Indeed, China has become a large consumer of a broad range of primary commodities over the last decade, reflecting its rapid economic growth.
As a result, the Chinese economy has come to play a dominant role in many industrial and agriculture commodities and the nation's appetite for commodities is now a key driver in their prices. Thus, the recent growing concerns in the sector in the face of China's economic slowdown are not surprising.
To put this in perspective, China's GDP grew 7.3% over the last quarter which is the weakest growth rate that the world's second largest economy has experienced in five years, sending commodity prices to multi-year lows. Industrial metals such as copper have slumped 11% in 2014 and 6.1% in the third quarter alone. Even more dramatically, iron-ore has dropped by more than 40% this year as growth in supply has continued to outpace demand in the world's top consumer. The big three global producers – Vale, Rio Tinto and BHP Billiton – have drastically been increasing production in their bid to dominate the industry, leading to a glut of the raw material on the markets.
It is of little surprise that against this market backdrop many commodity-related funds have delivered materially negative returns and an obvious consequence of this has been the massive outflows recoded over the last 18 months. 2013 saw the worst sell-off in many years and the bulk of the redemptions were gold related. Precious metals have lost their safe-haven appeal as signs of an improving U.S. economy boosted the case for less U.S. stimulus and the increasing likelihood for an interest rate increase.
Outflows have also continued this year albeit at a lower pace despite the first quarter being one of the strongest return periods for the sector in the past two years, with gold and energy being amongst the highest returning sub-sectors. The IMF data signalling a worldwide slowdown and the sharp contraction of the US economy during the first quarter provided support to gold prices while the spike witnessed in oil prices following the political unrest in Ukraine, Libya and Iraq led to a strong rebound in energy equities. With these record outflows and substantial losses, many banks such as JPMorgan, Barclays and Deutsche have recently decided to quit their commodity-related operations and some of the world’s biggest commodity hedge funds have also closed. Does this mean commodities are no longer viable investments?
There has been continued debate around the run of gains seen in prices (what many refer to as the commodities super-cycle) and that this may have come to an end. The combined forces of lower global demand and an ever growing supply over the last few years are driving prices lower, just as they drove them higher in the upswing. Similarly, the argument for investing in commodities as a hedge against rising inflation has weakened as many countries are slipping into a deflationary environment.
While prices for many commodities have drastically fallen, this does not mean that the sector is deprived of opportunities. Indeed, some managers believe commodities and resource equities exhibit better relative value than equities and fixed income which are trading on expensive valuations. Meaningful inflows in silver were recorded in the third quarter as investors viewed the low prices combined with some optimism about future demand for the metal as a buying opportunity.
It is also worth noting that if another country starts consuming at the same rate as China did in the past decade, this should support the sector. Many developing economies are consuming fewer raw materials and their consumption is likely to rise as they increase their manufacturing output and improve their infrastructure.
From the investors’ perspective, the natural resources equity sector is comprised of a diverse range of offerings with some funds covering all the main sub-sectors of the commodity complex, specifically energy, base metals, precious metals and agriculture, while other funds offer more restricted mandates with a narrower investment focus and therefore exhibit relatively higher risk. Given the niche nature of these investment and their associated risks, investors need to tread with caution and understand that the drivers of these funds’ returns are largely exogenous.
Commodity Funds Rated by Analysts
The BGF World Mining fund has a Morningstar Analyst Rating of Gold and has been managed by Evy Hambro since its launch in 1997. Hambro has developed outstanding expertise and knowledge in his field and has built one of the best resources teams. The management team seek to identify, through a rigorous assessment of commodities prices, established, high quality companies that they believe are undervalued by the market. The offering has attracted a large amount of inflows over the past decade.
The JPM Global Natural Resources fund is Bronze rated and is run by Neil Gregson who became lead manager in February 2012, when former manager Ian Henderson stepped back to a consultancy role in JPM’s Natural Resources team. The team aims to add value through material investments in small-cap stocks from pre-production stage/discovery to reserve definition using a bottom-up analysis that focuses on misvalued companies. This has led to a portfolio diversified across three key subsectors: energy, gold and precious metals, and base metals. The fund has benefited from its emphasis on riskier small companies during a period dominated by the 2009-10 recovery in resource and equity markets.
The Bronze-rated Investec GSF Global Natural Resources fund is managed by Bradley George, who heads the Investec Natural Resources team. It offers investors a diversified portfolio across the commodity spectrum, where stocks positions are selected through a commodity specific supply and demand analysis with detailed bottom-up research into the producing companies. The fund’s detailed and relatively unconstrained approach has so far benefited investors who are seeking broad, long-only exposure to resources equities.
