The choice in com­modi­ties

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The well-worn adage “all good things must come to an end” is es­pe­cially true for com­modi­ties price cy­cles, and for a while now in­vestors have been on a thrill-ride on­ward and up­wards as prices kept ris­ing.

But two key ques­tions emerge. For those on the out­skirts, the ques­tion is whether it’s too late to get in on the ac­tion. For peo­ple al­ready in­vested in re­sources, the ques­tion is how to know when the party is well and truly over.

Your money would al­most have dou­bled if you had in­vested in the JSE’s re­sources in­dex in the six months from early De­cem­ber 2015 to early June in 2016, when the oil price lan­guished be­low $50 a bar­rel and other com­modi­ties ex­pe­ri­enced marked lows.

That’s sig­nif­i­cantly more than the 17% re­turn you would have re­alised if you had cho­sen in­stead to put the cash in the JSE all share at that time.

The gen­eral min­ing in­dex has had a sim­i­larly spec­tac­u­lar per­for­mance, and for the first time in a decade has out­per­formed the Alsi.

Do­mes­ti­cally, bulk com­mod­ity prices like iron ore and coal have driven per­for­mance in the min­ing sec­tor in spite of con­tin­ued hard­ship for SA’s pre­cious metal sec­tors.

Nor­mally a re­source cy­cle is rel­a­tively sim­ple, says Wayne McCur­rie of FNB Wealth & In­vest­ments. The econ­omy goes into a re­ces­sion, re­source prices drop, the econ­omy fal­ters and stock mar­kets and in­ter­est rates fall. Not long af­ter the de­crease in the in­ter­est rate de­mand picks up and com­mod­ity prices fol­low.

The pre­vi­ous cy­cle — the so-called su­per­cy­cle that ended in 2008 — was dif­fer­ent, how­ever, be­cause com­mod­ity com­pa­nies spent enor­mous amounts to in­crease pro­duc­tion in ex­pec­ta­tion of ever in­creas­ing de­mand.

Com­modi­ties com­pa­nies are strange beasts. They can af­ford to ex­pand only at the top of the cy­cle — that’s the only time share­hold­ers al­low them to do it

About $60bn of capex was spent in each year of this su­per­cy­cle, McCur­rie says.

“Nor­mally com­mod­ity prices col­lapse be­cause of de­mand [drop­ping off].

“This time de­mand was still there, though it wasn’t fan­tas­tic. The prob­lem was that there was too much in sup­ply,” McCur­rie says.

As a re­sult, mines had to cut back dras­ti­cally on both sup­ply and capex to stay afloat.

That was true for all the ma­jor com­modi­ties: coal, cop­per and iron ore, and even oil, though the latter has dif­fer­ent driv­ing fac­tors be­cause pro­duc­tion is largely con­trolled by the Opec car­tel.

To­day there’s a fairly good bal­ance be­tween de­mand and sup­ply, and prices have re­cov­ered to the point where min­ing com­pa­nies are ex­tremely prof­itable. “Many al­most went bank­rupt in 2008, but [they] are now the lean­est and mean­est they have been in more than 50 years,” McCur­rie says.

Com­modi­ties prices are nowhere near the highs seen dur­ing the su­per­cy­cle, yet th­ese com­pa­nies are vir­tu­ally print­ing cash. “Be­cause they’ve cut on capex, the money is flow­ing into their bank ac­counts and paid out through div­i­dends,” says McCur­rie, who has a good earn­ings out­look for th­ese com­pa­nies.

But there are a few signs to look out for that would in­di­cate it could be time to sell, he says.

One is ris­ing global in­ter­est rates. “That’s the first warn­ing sign that fu­ture eco­nomic con­di­tions will not be as good as they are at the time.”

Cer­tainly, that is hap­pen­ing now. The US Fed­eral Re­serve has pur­sued a rate-hik­ing cy­cle for the past two years. It re­cently in­creased rates for the third time this year, and

Mines had to cut back dras­ti­cally on both sup­ply and capex to stay afloat. That was true for all the ma­jor com­modi­ties

warned of an­other be­fore the year is out. “I don’t think this will end in dis­as­ter, but you never know,” McCur­rie says.

The sec­ond warn­ing sign is when min­ing com­pa­nies start ramp­ing up cap­i­tal ex­pen­di­ture. But this is not as yet a per­va­sive trend.

Ac­cord­ing to PWC’s “Mine 2018” re­port, re­leased in July, the level of cap­i­tal ex­pen­di­ture among the top 40 min­ing com­pa­nies has re­mained at its low­est over the past 10 years, and the firms con­tinue to prac­tise cap­i­tal dis­ci­pline. In a nor­mal cy­cle, the com­pa­nies would even­tu­ally give in to temp­ta­tion and pur­sue new projects and ac­qui­si­tions.

“Com­modi­ties com­pa­nies are strange beasts,” says McCur­rie. “They can af­ford to ex­pand only at the top of the cy­cle — that’s the only time share­hold­ers al­low them to do it. In terms of cash flows, they are coun­ter­cycli­cal.”

The fi­nal warn­ing sign is in­cred­i­bly high com­mod­ity prices. In McCur­rie’s view the ab­so­lute level of th­ese prices is not at its high­est just yet. “We are prob­a­bly 80% of the way through the cy­cle,” he says.

Oil, for ex­am­ple, had re­cov­ered to $80 a bar­rel at the time of writ­ing, but it’s nowhere near the $110 re­alised in mid-

2015. Iron ore is $70/t — much bet­ter than $40 in late 2015 — but far from the $160 that was reached in mid-2013.

“So we’ve got one and a half [warn­ing] signs out of three. I don’t think we are there yet. But in­vestors should start be­ing cau­tious.”

Stephen Mein­t­jes, head of re­search at Mo­men­tum Se­cu­ri­ties, says it could be that the cy­cle has peaked. Prices have, in fact, held up longer than many ex­pected. “A lot of peo­ple thought we would have been in a phase of fall­ing com­mod­ity prices now,” he says.

There are a few rea­sons why they haven’t, he says. For one, China has gone on a huge an­tipol­lu­tion drive and so is seek­ing out higher grades of coal and iron ore.

The re­sources stocks are not wildly over­val­ued, though they have re­acted to the rise in prices, Mein­t­jes says.

Though broadly the same fac­tors drive var­i­ous com­mod­ity price cy­cles, it’s im­por­tant to note that no com­mod­ity price cy­cle is the same, says Arnold van Graan, min­ing an­a­lyst at Ned­bank Cor­po­rate & In­vest­ment Bank­ing. In the su­per­cy­cle it was driven by the China growth story, he says. “The world was run­ning out of metal. But then it fell in a heap on the back of the global fi­nan­cial cri­sis.”

This time around there’s a move to­wards new tech­nolo­gies and ar­ti­fi­cial in­tel­li­gence to be con­sid­ered. There are also a po­ten­tial slow­down in China, the threat of trade wars and other geopo­lit­i­cal risk — “all of th­ese are fac­tors that didn’t ex­ist in the pre­vi­ous cy­cle”, Van Graan notes.

Mein­t­jes says pro­duc­ers of plat­inum group me­tals are qui­etly op­ti­mistic about the out­look for metal prices.

How­ever, pre­cious me­tals such as plat­inum and gold are driven by dif­fer­ent fac­tors.

Plat­inum is con­sid­ered a “late cy­cle” com­mod­ity — its price rise lags be­hind that of key com­modi­ties such as iron ore, coal and cop­per.

Cer­tainly, plat­inum is yet to ex­pe­ri­ence a lift.

In fact, in Au­gust it hit lows that were last seen a decade ago, when the price slid be­low $800/oz — well be­low its his­tor­i­cal mean of about $925/oz.

For gold, Van Graan says the in­vest­ment ad­vice is sim­ple — “You re­ally want to buy th­ese stocks when no-one else wants to touch them,” he says.

“His­tor­i­cally one has not been able to per­suade in­vestors to look at th­ese stocks, de­spite com­pa­nies be­ing in good shape. But once they start to run, ev­ery­one is ask­ing about it. It’s al­most a cliché.” SA’s gold stocks, in par­tic­u­lar, is ever a long-term in­vest­ment, and Van Graan warns: “There’s a big ques­tion mark over their longterm vi­a­bil­ity as as­sets.”

McCur­rie says com­modi­ties are not long-term in­vest­ments. “They are all highly cycli­cal and in­cred­i­bly volatile.

“If you were a true longterm in­vestor — and I’m yet to meet one — you would not own a com­mod­ity share; it’s too risky.”

Pro­duc­ers of plat­inum group me­tals are qui­etly op­ti­mistic about the out­look for metal prices. But me­tals such as plat­inum and gold are driven by dif­fer­ent fac­tors


Pic­ture: 123RF — PAVEL IGNATOV

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