The commodities sector was impossible to ignore last year, with the oil price rising by approximatel...
The commodities sector was impossible to ignore last year, with the oil price rising by approximately 40%. Meanwhile, copper prices reached new records and other metals, such as zinc, hit their highest price for many years.
However, commodities have fallen back recently, with resources such as oil, gold and copper declining sharply. This has left many investors questioning whether the commodities bull run is over and whether now is the time to take profits and run.
This current weakness in the commodities sector should be seen as a good buying opportunity. Natural resources stocks will continue to offer a compelling investment because the demand/supply dynamics of the sector should continue to help drive share prices higher in the future.
The massive economic development of emerging markets, such as China and India, is ensuring demand for commodities remains high. At the same time, suppliers are struggling to keep pace with this rapid increase in global demand following years of underinvestment.
A key source of this sustained demand is from the developing economies in Asia. A prime example of this is China. Over the last decade, China's rapid industrialisation has created a high demand for consumer goods and raw materials, with it now the world's most significant importer of many key commodities, including copper, oil and iron ore.
In the last 10 years, China's demand for copper has more than doubled and this demand is set to rise even higher. Over the next 10 years, China has plans to build 20 regional airports and two high-speed rail networks as well as carry out a huge expansion to its electricity network.
As China transforms itself into an industrialised nation, it will demand ever increasing amounts of oil to help this transition. On the consumer side, as more of the population becomes middle class, more Chinese will be able to afford luxury goods, including diamonds. It is also likely China will become the world's largest jewellery market in the coming years.
At the same time as global demand is exploding, supplies are dwindling due to chronic underinvestment. There is no quick or easy way to boost supplies of many commodities, as it is estimated in most cases it takes between five and 10 years to bring new capacity online.
In the case of oil in particular, years of underinvestment in exploration and refining capacity, as well as dwindling physical reserves, means there is a growing gap between oil discoveries and consumption. Environmental factors, such as Hurricane Katrina, which wiped out oil production in the Gulf of Mexico last autumn, are also having a severe impact on supplies, as are political struggles in Venezuela and civil conflicts in Nigeria and elsewhere. As a result, spare capacity is no longer available to cushion spikes in demand and oil prices are expected to remain strong for years to come.
For long-term investors, the compelling combination of taut supply and rising demand is made more compelling by the fact stock valuations in the sector remain highly attractive. Although commodity prices are likely to remain strong for years, prospects for further upward revisions to near and medium-term earnings prospects have yet to be reflected in share prices.
Commodities' weakness means opportunity to buy
Demand still strong in emerging markets
Stock valuations attractive
Service increasingly key
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