The world’s largest mining companies are starting to report their results and several have published trading updates that show beyond any doubt that commodity markets are booming.
A short sentence from BHP Group’s operational update for the year to June 2021 says it all: “BHP is in great shape,” CEO Mike Henry told shareholders.
He says BHP set several production records and commissioned four major projects safely, on schedule and on budget. “We achieved production records at our Western Australia iron ore operations and the Goonyella Riverside metallurgical coal mine in Queensland.
“We maintained all-time high concentrator throughput at our Escondida copper mine in Chile. Olympic Dam in South Australia had its highest annual copper production since BHP acquired the asset in 2005, and its best-ever gold production,” says Henry.
Companies obviously only produce what they can sell – and sell they did, if market prices are anything to go by.
The BHP update shows that commodity prices continued to increase during the six months to June with copper – often seen as an indicator for economic growth and the health of commodity markets – increasing by another 31% compared with the preceding six months.
The average copper price over the last six months is 82% higher than the average for the same six months a year ago. Using the same reference points, iron ore increased by more than 100%.
Moneyweb asked Philipp Wörz, fund manager at PSG Asset Management, about the state of the commodities boom and whether investors are benefiting.
“Commodities have indeed been booming lately. Copper is 95% higher than in March 2020 and 50% above pre-Covid-19 levels. It has been reaching levels last seen in 2011,” says Wörz.
He notes that oil is back at $70, at levels that “were not supposed to be possible in a world phasing out fossil fuels”, and with technological advances in oil and gas extraction that were supposed to increase supply and keep prices low.
“Even thermal coal, which many market participants declared dead not long ago, nearly tripled in price since last year and has made fresh 10-year highs recently,” says Wörz.
This is the second commodity bull market in two decades, he adds.
“Similar to 2007, there is current debate around the likelihood of a commodity supercycle – a time when commodity prices trade above their long-term trends for an extended period.
“In 2007, it was argued that rampant Chinese demand had given rise to a supercycle and, indeed, commodity prices were high in subsequent years. Today, arguments in favour of a supercycle focus on the lack of new supply to meet the future demands imposed by decarbonisation and expansion of infrastructure.”
Wörz says the forces driving commodity markets are complex, but provided a brief overview: “Economies emerging from Covid-19 lockdowns, coupled with relatively tight supply, have been major factors driving markets.
“Commodity markets tend to move in pronounced cycles. Despite sporadic surges in demand, such as we have witnessed in China this century and are likely to see as part of the green revolution in coming years, it often takes supply a long time to respond.
“To illustrate, an operator starting from scratch will likely take more than 10 years to develop a new large-scale copper project,” says Wörz.
He noted that in response to China’s insatiable demand for commodities, capital expenditure in the mining sector increased materially from 2005 to 2012 – which resulted in metals flooding the market from 2012 to 2015, and pushed prices lower. “Many miners had near-death experiences in 2015.”
“Importantly, this had a pronounced impact on subsequent investor psychology,” says Wörz.
“The mantra from the institutional shareholder base has been to prioritise restoring balance sheets, and only thereafter focusing on capital returns to shareholders.
“It contributes to limiting new supply and will likely prolong the current trend in prices.”
Are SA investors investing in resource companies and benefiting from the boom?
Fortunately for them, the JSE has been big on mining and commodity stocks ever since its establishment in the mining town of Johannesburg in 1887. SA investors are likely to benefit.
“It is also important not to forget the SA economy’s dependence on the fortunes of the commodities,” says Wörz, noting that the trade surplus and strength in the rand up to June should serve to remind us of the windfall that results from surging commodity prices, especially platinum group metals.
“However, a feature of the current investment environment is that global portfolios are heavily exposed to the winners of the past – passive, growth stocks and the US – and the weightings of sectors like materials and energy in indices are low.
“Despite the run-up in commodity prices and recent price performance, we still believe that many stocks can be acquired at attractive valuations. While resources stocks are volatile in nature and have had a strong run over the past year, many are still on favourable valuations.
“Commodity companies will return a lot of cash to shareholders and can serve as cheap hedges against future inflation, making them a compelling part of a portfolio,” says Wörz.
He sees evidence of a rotation from big, arguably expensive, technology stocks to resource counters.
“While we believe there are many great technology companies out there, our view has been that high valuations in the technology sector do not compensate us for the risk taken,” he says.
He points to the very high weightings of tech stocks relative to commodity shares to illustrate the potential. The weighting of the entire energy and materials sectors in the MSCI World Index reduced from 11% in June 2017 to 7.5% by June 2021, similar to the joint weights of Apple and Microsoft at 7.3%.
“The situation in the US market is even more extreme, with Apple at 6.3% of the S&P 500 being larger than materials and energy combined [5.1%].
“Given the attractive set-up we currently see in energy and materials stocks, we have increased the allocation to energy and materials in our portfolios,” says Wörz.
Share prices are showing the change in sentiment …
Anglo American increased 71% from its 12-month low, while BHP ran 56% and Kumba 58%.
Sasol is up 212% from its 53-week low due to continued recovery and higher oil prices, but mainly as a result of the share plunging to a very low low of only R75 in October last year.
At current share prices, the historic price-earnings ratios of commodity shares are between 10 and 16 times – before the expected good results due shortly – which seem to prove Wörz’s argument that commodity shares are still offering value.
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