Neil Gregson, manager of the JPM Natural Resources fund, looks at the new opportunities in commodities...
This year’s third quarter witnessed a significant recovery in resource equities. Cyclical sectors strongly outperformed defensive sectors and MSCI Materials was the best performing sub-sector, although it is still lagging year-to-date. This supports our belief that, overall, the commodities sector has finally troughed.
From a fundamentals perspective, we have begun to see early signs of improvement, notably in the mining sector, with leading indicators turning upward, while valuations remain near multi-year lows. With commodity prices recovering, we should see an end to the two-year earnings downgrade cycle for producers.
Investor attention may now shift to the positive restructuring and cost-cutting initiatives underway in the sector, as well as the supportive supply-side issues to come.
Why I believe the commodities sector has finally troughed
Investors continue to keep a close eye on the impact Chinese growth has on commodity consumption. Although annualised steel production in China is up by just over 10%, which is positive for iron ore prices, distributors are running down their inventories, primarily as a result of additional supply coming from Australia.
We expect this to lead to a short term weakening in the price of iron ore and have trimmed our exposure slightly. Meanwhile, base metal prices stand to benefit from increased demand from developed economies, which account for around 60% of global metal demand.
We have recently seen a recovery in the Chinese property market and authorities are pushing ahead with low-cost housing initiatives, which will be commodity-intensive and, thereby, supportive of metal demand.
Upward price pressure
With the exception of iron ore, most commodities are still languishing near trough prices. This has had the effect of knocking out supply, with zinc mines, nickel mines and aluminium smelters closing as producers struggle to cover their costs.
The coal industry, in particular, has been hard hit. However, reduced supply at the industry level benefits the remaining producers as it exerts upward pressure on prices.
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