This booming sector shows no signs of slowing down as war in Ukraine cuts commodity supplies and ‘energy security’ takes centre stage.
Commodities are on track to be the best trade of the year as calls to “onshore” key supply chains increase demand for critical raw materials, and as the war in Europe sends food and energy prices higher.
So far this year, the Dow Jones Commodity Index has risen 25%. It includes 23 commodities across four areas: energy, metals, agriculture and livestock. A barrel of oil has risen from $79 to just over $100.
In contrast, global shares have fallen 4%, US shares are down 6.5% and the UK market is off 1%.
Bank of America’s latest survey of professional investors found that aside from moving to cash, fund managers were buying commodities. The allocation to natural resources, such as oil, copper and gold, as well as the mining firms that extract them, is now at a record high. Around two-fifths of respondents thought oil stocks would produce the best returns in 2022.
The bank’s own researchers have also made energy its highest conviction investment call for 2022 despite the sector’s strong performance already this year.
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It said that there are three key tailwinds for the sector. First, energy security is now a priority for governments, calling it the “oxygen to the economy” in the wake of boycotts on Russian oil and gas. This means more investment in fossil fuels and renewable energy.
Second, it argued that despite a big bounce back for energy shares, investors were still underweight the sector relative to the US stock market. Therefore, there’s plenty of scope for investors to increase exposure, which could drive prices of oil companies higher.
Third, it said the huge amount of cash that oil stocks generate made them an attractive investment.
The bank said: “Energy companies are expected to generate inflation-proof free cash flow yield of 15% this year, a record level in our data history since 1986. Despite a 38% rally in energy year to date, the sector’s valuation is still attractive given the backdrop of high inflation and a rising cash yield.”
A switch to renewable and nuclear energy, which has been pushed up the agenda even more following war in Europe, will actually increase raw materials' prices even more, according to Barry Norris, chief investment officer at Argonaut Capital.
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He said: “A renewable grid will produce abundant electricity for a few days annually and prohibitively expensive and unreliable power the rest of the time, resulting in demand destruction and supply rationing. This is a monumental misallocation of capital and a generational policy folly.
“The economic consequences may well be deindustrialisation, loss of blue-collar manufacturing jobs, loss of energy security and economic recession, akin to that witnessed in the 1970s with the OPEC oil shocks and the three-day week.
“This will create an economic stagflation resulting in rising interest rates, structural inflation, and negative real returns on all asset classes apart from commodities for investors.”
Jeremy Grantham, co-founder of fund group GMO, also believes commodities will perform well as economies switch to renewable energy and electric vehicles.
He argues that a clean energy revolution would cause demand to spike for metals used in batteries, such as lithium and nickel.
He said: “Decarbonising our economy will be spectacularly resource-intensive, and all key commodities required are finite in supply.
“Many of the most important industrial metals are extremely scarce, and the best deposits have already been consumed. The average ore grade of active copper mines, for example, is estimated to have fallen from about 2.5% 100 years ago to about 0.5% today.
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“Nickel, lithium, cobalt and copper are all essential to the modern economy – and particularly critical for decarbonising industry – but each makes up only 0.002% to 0.006% of the Earth's crust, compared to iron at 5% and aluminium at 8%.”
Grantham believes that large-scale deployment of windmills, solar farms, and transmission lines will be very resource intensive, therefore profiting mining companies.
He said: “The electric vehicle is likely to consume 15 times the current annual global lithium supply by 2050.
“Nearly all of the investment to generate 30 or 40 years of power from a wind or solar farm is up front – whether measured in money, resources, or energy.
“Even basic measures such as insulating homes require real investment first with their payoff later. Perhaps the last great irony of the fossil-fuel era will be that going off fossil fuels in the long run will require using one more spurt of fossil fuels in the short run.”
How to profit
Investors can profit from rising natural resources prices by buying active funds and ETFs. The top natural resources funds so far this year include Schroder ISF Global Energy, JPM Natural Resources, Guinness Global Energy, and BlackRock Natural Resources Growth & Income.
Passive funds track baskets of commodities, such as the L&G All Commodities ETF, which charges 0.16%. The iShares Diversified Commodity Swap ETF also tracks this index for the slightly higher fee of 0.19%, as does the Invesco Bloomberg Commodity ETF.
Another option, which carries a higher fee of 0.35% a year, is WisdomTree Enhanced Commodity ETF. A key difference between this ETF and the others stated above is that specific futures contracts used to gain commodity exposure are chosen with the best, or optimal, return in mind. The ETF is a member of interactive investor’s Super 60.
For investors looking for ways to gain exposure to oil, the simplest way is to back an exchange-traded commodity (ETC) tracking the price, such as the WisdomTree Brent Crude Oil ETC and the WisdomTree WTI Crude Oil ETC .
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