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Commodities have collectively skyrocketed, breaking down the six best ways to invest

Article | Barron's Weekly Writer Andrew Bary (Andrew Bary)

Editor | Guo Liqun

On February 18, the first trading day of the Year of the Ox, commodities collectively skyrocketed. After a lapse of one year, international oil prices once again reached 62 US dollars/barrel. In the A-share market, the petrochemical, coal, black, and non-ferrous sectors registered the highest gains. All signs suggest that after 10 years of bear markets, the commodity market is about to enter a boom period.

After a 10-year bear market, the commodity market began to recover. Natural resources such as energy, metals, and agriculture are expected to usher in a long-term upward trend, and investors should prepare for this.

Goldman Sachs (Goldman Sachs) analysts say that the recovery in commodity prices “will actually start a longer structural bull market”, which is probably comparable to the bull market in the 70s of the last century (when gold prices rose 25 times) and the mid to late decade of this century (oil prices peaked at more than $140 per barrel).

There are plenty of reasons to be bullish. By the second half of 2021, the global economy is expected to recover as restrictions related to the pandemic are relaxed. At the same time, the current monetary environment is also very relaxed. The Federal Reserve may keep short-term interest rates close to zero from now until 2023, while allowing the inflation rate to rise above 2%.

Roland Morris (Roland Morris), commodity strategist at VanEck, said, “Commodities have been outperforming other asset classes for a long time, and now we are expected to usher in a period of outperforming. First, countries around the world are implementing large-scale fiscal and monetary stimulus measures. Second, as global economic growth rebounds, the dollar is likely to fall. Third, the insufficient supply of industrial metals under the trend of electrification will bring new demand.”

After 10 years of low returns, there is a “structural underinvestment” in commodities (particularly in the energy sector), which is part of the reason Goldman Sachs commodity analysts are bullish. Although the S&P Goldman Sachs Commodity Index (S&P GSCI) has recovered 66% from its April 2020 low, the total return over the past 10 years was -60%, while the S&P 500 had a total return of 263% over the same period.

Influential university endowments such as Harvard and Yale have long invested in commodities to diversify their investments while hedging the risks of equity investments and bonds. Now, retail investors can also consider doing this, increasing the share of commodities in their portfolios to 10% or more.

There are two main ways to invest in commodities: one is to buy funds that hold physical or futures contracts for commodities, and the other is to buy stocks of companies that produce commodities.

Commodities may not be the first choice for environmentally-conscious investors. However, even in the “green economy,” demand for commodities is increasing.

Take copper, which can conduct electricity, for example. Currently, there are no particularly suitable alternatives to copper wire; electric vehicles require four times as much copper as internal combustion engine vehicles; onshore wind farms are four times more copper-intensive per megawatt than traditional power plants.

The best investment target in the copper sector isFreeport-McMoRan (FCX)$Freeport-McMoRan (FCX.US)$The company derives 80% of its revenue from copper and owns copper mines on several continents.

If supply eventually catches up with demand, commodity producers could be hit. From this perspective, investing in stocks of companies with excellent business models is better in the long run than investing in stocks of companies that only own or produce hard assets.

But there is another opposite view:Rio Tinto (RIO)$Rio Tinto (RIO.US)$withBHP Billiton (BHP)$BHP Group Ltd (BHP.US)$Mining giants with more shareholder-oriented management methods are controlling capital expenditure and paying more attention to dividends, so the supply of many industrial commodities may be limited in the next few years.

Charles Malan (Charles Malan), senior analyst of natural resources stock strategy at VanEck, said, “Companies that were focused on scaling up 10 years ago are no longer investing in new projects, but are returning cash to shareholders.” Mullen was referring to Rio Tinto and BHP Billiton.

Furthermore, more and more countries are opposed to mining new mines due to environmental considerations, and the value of existing mines has increased as a result.

Jefferies (Jefferies) analyst Chris LaFemina (Chris LaFemina) pointed out that it may take ten years to develop a new copper mine. “Several major commodities, including copper, are entering a period of tightening supply and rising prices,” he said.

Rio Tinto's dividend yield is close to 5%, top gold mining companyNewmont (NEM)$Newmont (NEM.US)$The dividend yield is 2.5%. Compared to the 1.5% dividend yield of the S&P 500 index and the insignificant 1% yield on many treasury bonds and municipal bonds, the yield of these two stocks is already quite good.

Mining companies are better managed than ever, and their balance sheets are strong. As mining companies reduce carbon emissions and waste, environmental issues have also become a new focus of attention. Some investors focused on sustainable investments are beginning to realize that mining is critical to the global economy and that mining companies can produce in a more environmentally friendly way.

Although renewable energy is growing, there is still an opportunity for energy stocks to rise, as oil and gas are likely to play an important role in driving the global economy in the coming decades.

In terms of risks faced by commodities, since China is a major consumer of commodities, commodity prices will be hit if China's economic growth suffers a setback. However,All signs indicate that the commodity market is about to enter a boom period. Here are some ways to invest in commodities.

Direct investment in commodities

Major commodity ETFs includeInvesco Optimum Yield Diversified Commodity Strategy No K-1 (PDBC), Invesco DB Commodity Index Tracking (DBC), GraniteShares Bloomberg Commodity Broad Strategy No K-1 (COMB), and iShares S&P GSCI Commodity-Indexed Trust (GSG)。

Invesco Optimum Yield is larger than Invesco DB Commodity and is an actively managed ETF. GraniteShares has an annual rate of 0.25%, compared to its competitor's annual rate of 0.59%, or even higher.

There are two main indices in the commodities sector, namely the S&P Goldman Sachs Commodity Index and the Bloomberg Commodity Index. The difference between the two is the weight of energy stocks. Energy stocks account for about 60% of the S&P Goldman Sachs commodity index, and energy stocks and agricultural stocks each account for a quarter of the Bloomberg commodities index.

Energy stocks account for 55% of Invesco DB Commodity, and the remaining 45% are metals stocks and agricultural stocks, respectively. Jason Bloom (Jason Bloom), head of ETF fixed income and alternative investment strategies at Invesco, said that since energy stocks are most closely related to rising commodity prices, Invesco DB Commodity can help investors diversify their investments and hedge against the risk of inflation.

Will Rhind (Will Rhind), CEO of GraniteShares, said, “The benefit of the GraniteShares commodity ETF is that the fees are low and there is no need to file K-1 taxes.”

Popular commodities

To participate in commodity growth, investors can buy funds that hold physical commodities or futures contracts, or they can buy stocks of companies that produce commodities. Here are a few funds and stocks to consider — including energy, metals, and agriculture.

The largest single commodity ETFs include those with a scale of $69 billion and gold barsSPDR Gold Shares (GLD)$SPDR Gold ETF (GLD.US)$, the one with a lower rateiShares Gold Trust (IAU)withiShares Silver Trust (SLV). Other single commodity ETFs include tracking West Texas Intermediate OilUnited States Oil (USO)withAberdeen Standard Physical Platinum Shares (PPLT)。

The advantage of commodity ETFs is that they provide investors with the opportunity to directly invest in commodities. One risk for commodity funds that use or track futures is that the forward price may be higher than the spot price, and these funds will lose money when replacing old futures positions with new futures positions with a later maturity date (same execution price).

energy

Energy is the world's most important commodity, and energy producers are finally starting to control capital expenditure.

Renewable energy policies advocated by US President Joe Biden may curb demand for oil and gas, but restrictions on drilling and pipeline construction could strain supply.

Bill Smead (Bill Smead), manager of Smead Value Fund, said, “After 25 years, probably everyone will drive an electric car, so gasoline will fall out of favor. But this will not happen until a long time later, and producers can make a lot of money selling gasoline over the next 25 years.” He said natural gas will play a key role in generating electricity. Energy stocks weigh about 10% in Smid's fund, compared to 2.5% of energy stocks in the S&P 500 index.

Investors looking to invest in energy stocks can considerExxonMobil (XOM)$Exxon Mobil (XOM.US)$withChevron (CVX)$Chevron (CVX.US)$Wait for companies that are optimistic about the future of the energy industry, not big European companies such as British Petroleum (BP).

Faced with pressure from environmentalists and European investors, European oil giants are no longer paying as much attention to traditional energy projects as in the past, and these companies have the most experience in these fields. They have increased their focus on renewable energy projects, but they have shown no advantage in this regard.

ExxonMobil's production is expected to remain around 4 million barrels per day for the next five years. Recently, the company was favored by Wall Street because investors believe that due to rising oil prices, ExxonMobil can maintain its 7% dividend yield.

Morgan Stanley (Morgan Stanley) analyst Devin McDermott (Devin McDermott) recently upgraded ExxonMobil's rating from “hold and wait” to “increase” and set the target price at $57 (recently $46), citing “improved prospects” for the company's free cash flow and continued dividends.

The Chevron that Schmidt is most optimistic about is in better condition than ExxonMobil. Chevron's dividend yield is stable at 5%, and for the past 25 years, Chevron has owned both the oil business and the popular liquefied natural gas business.

Smid is still optimisticContinental Resources (CLR)$Continental Resources (CLR.US)$It is an exploration and development company based in the Bakken Oilfield in North Dakota. He said that even if debt is taken into account, the company's abundant oil and gas reserves can push the stock price to continue to rise several times from the recent $21.

Long-standing sluggish gas prices are likely to be boosted by utility demand as some companies shut down coal-fired power plants, and overseas demand for liquefied natural gas extracted from US natural gas continues to grow.

In natural gas stocks,Cabot Oil & Gas (COG)$Cabot Oil & Gas Corp (COG.US)$It is the blue-chip stock with the best balance sheet, followed by the largest gas producer in the USEQT (EQT)$EQT Corp (EQT.US)$. Kopernik Global All-Cap Fund Manager Dave Iben (Dave Iben) favors producers with higher leverageSouthwest Energy (SWN)$Southwestern Energy (SWN.US)$withRange Resources (RRC)$Range Resources (RRC.US)$He believes that both companies' stock prices may double.

He is also optimistic about Russian energy giantsGazprom (OGZPY)$Gazprom PJSC Sponsored ADR (OGZPY.US)$, calling it “the world's largest, lowest-cost, and most powerful natural gas company.” Gazprom claims that its proven energy reserves are huge, mostly natural gas. The energy reserves are equivalent to about 125 billion barrels of oil, while ExxonMobil's reserves are about 22 billion barrels. Gazprom's US-listed stock is priced at around $6 and has a dividend yield of 5%.

copper and iron ore

The two largest mining companies, BHP Billiton and Rio Tinto, mainly produce iron ore. The price of iron ore has doubled in the past year to 160 US dollars per ton. Since mining costs less than $40 per ton, both companies have made huge profits. The share price of BHP Billiton is around $70, the dividend yield is 3%, Rio Tinto's share price is $79, and the dividend yield is 4.8%. Based on expected profits in 2021, both stocks have price-earnings ratios of about 10 times.

VanEck's Mullen said that some large mining companies have free cash flow returns of more than 10%, and dividends are likely to rise. VanEck holdsRio Tinto, Anglo-American Resources Group (NGLOY)$ANGLO AMERI PLC (NGLOD.US)$and Freeport-McMoRanof the stock.

“These companies are in a very healthy financial position. At a time when dividend yields are rising and capital expenses are being reduced, these companies will attract a new group of shareholders, which in turn will drive up the share price,” Mullen said.

Jefferies Lafimina is optimistic about multinational mining companiesAnglo-American Resources Group. The company is more diversified than Rio Tinto and BHP Billiton, and has extensive copper business, as well as scarce platinum, palladium, and diamond assets [the company owns the diamond mining company De Beers (De Beers)].

“Anglo-American Resources Group is unique among diversified mining companies because the company can grow,” Rafimina said. He was referring to a large-scale copper project operated by the company in Peru, which is one of the few new copper mines.

He is also optimistic about Anglo-American Resources Group's diamond business. The business was hit hard after the outbreak of the epidemic in March last year and has now recovered strongly. Rafimina rated Anglo-American Resources Group as a “buy” and believes that the stock has room to rise by about 25%. The share price of Anglo-American Resources Group's US listed stock is currently around $17.

Freeport-McMoranThe profitability is very strong, and its cash flow is expected to double this year because the price of copper has risen by about 40% over the past 12 months to $3.60 per pound, while the company's cost is less than $1.50 per pound. Freeport-McMoRan can use its generous free cash flow to repay debts and possibly resume dividends.

“Copper prices are likely to rise sharply due to the imbalance between supply and demand,” Rafimina said. He also said that the price of copper may break through $5 per pound. He rated Freeport-McMoRan a “buy” with a target price of $36.

gold and silver

After the integration of the gold mining industry, two giants emerged:Barrick Gold (GOLD)$Barrick Gold (GOLD.US)$withNewmont. Joe Foster (Joe Foster), joint fund manager at VanEck International Investors Gold (INIVX), said, “The gold mining industry has never been as healthy as it is now.”

Both companies are highly profitable because the price of gold is currently around $1,850 per ounce, while the total operating costs of both companies are under $1,000 per ounce.

Newmont's recent stock price was 61 US dollars, and the recent stock price of Barrick Gold was 22 US dollars. Both stocks are down 20% or more from the high in August last year, and the price-earnings ratio is about 15 times based on expected profits in 2021. Newmont raised its dividend in the second half of 2020, and the dividend yield is now 2.6%. According to a formula that links dividends to the price of gold, the company is likely to raise dividends even more.

VanEck Vectors Gold Miners (GDX) and VanEck Vectors Junior Gold Miners (GDXJ) are two major gold mining ETFs, and the former is included inNewmont, Barrick GoldwithFranco-Nevada (FNV)$Franco-Nevada (FNV.US)$etccompany, the latter includedPan American Silver (PAAS)$Pan American Silver (PAAS.US)$withGold Fields (GFI)$Gold Fields (GFI.US)$etccompany.

The price of silver was boosted by increased adoption of electronics and solar panels, and the price of silver rose 50% over the past year to $27 per ounce. Since silver is a by-product of many mining operations, there are no large producers of pure silver. One of North America's largest producers of silver is Pan American Silver, yet less than half of its reserves are silver.

The stock with the largest holdings of the Global X Silver Miners ETF (SIL) is Wheaton Precious Metals (WPM), which is not considered a mining company, but has the right to produce gold and silver around the world. Investing in this company can obtain exposure to precious metals without the risk associated with mining.

uranium

Investors rarely pay attention to uranium, but Kopernik's Ibn is optimistic about this asset. Ibn believes that the current uranium price has dropped from a peak of more than 100 US dollars per pound more than 10 years ago to 30 US dollars, and needs to be “doubled or quadrupled” to stimulate the development of new production capacity to meet global demand for nuclear reactors.

With the construction of new reactors, mostly in Asia, uranium demand is expected to increase by 40% by 2040. The most fueled US is shutting down some nuclear power plants (such as the Indian Point nuclear power plant in northern New York), but China and India see nuclear power as a very attractive source of carbon-free electricity.

Ibn is optimistic about Canadian uranium producersCameco (CCJ)$Cameco (CCJ.US)$The company's stock price is currently around $13. Cameco closed a large uranium mine because prices were too low, and investors could see the company as an unconventional green energy investment.

farming

Climate and international demand are driving up food prices in the US. Brazil's dry weather may cause soybean production to decline, and demand for soybeans from raising pigs in China has always been strong. The price of corn in the US is currently $5.40 per bushel, up 40% last year, and the price of soybeans rose 50%, close to $14 per bushel.

Investors can go throughInvesco DB Agriculture ETF (DBA)$Invesco DB Agriculture Fund (DBA.US)$Get exposure to various agricultural products, with corn, soybeans, sugar, and coffee weighing 12% to 13%. The ETF's price is currently around $16.50, up 23% from its June 2020 low, but has only had positive returns in the past 10 years.

Leading agricultural equipment manufacturerDeere (DE)$Deere (DE.US)$The stock price has risen 80% over the past year to $290, as the market expects the agricultural economy to be more prosperous. Deere's projected price-earnings ratio is more than 20 times. Investors can also consider fertilizer producersCF Industries Holdings (CF)$CF Industries Holdings (CF.US)$and manufacturers of agricultural equipment and industrial vehicle wheelsTitan International (TWI)$Titan International (TWI.US)$Both stock prices have risen sharply from 2020 lows. Titan's stock price, which has a high leverage ratio, is 6.50 US dollars, and fell to 1 US dollar in March last year.

At a time when the inflation rate is rising and the Federal Reserve continues to implement an easing policy,The commodity outlook is improving, and it is likely to repeat the historic upward trend of the 70s of the last century。

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An original article from “Barronschina” (barronschina), may not be reproduced without permission. For the English version, see the February 1, 2021 report “After 10 Years of Underperformance, Commodities Are Set to Boom. Here's How to Play the Rally.” (The content of this article is for reference only. The investment advice does not represent the trend of “Barron's”; the market is risky, so you should be careful when investing.)

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