Commodities: Why the recovery may continue

The commodity cycle improved in 2016, and there are some reasons to think that trend may continue.

  • Investing in Stocks
  • Commodities
  • Commodities Funds
  • Investing in Stocks
  • Commodities
  • Commodities Funds
  • Investing in Stocks
  • Commodities
  • Commodities Funds
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print

Could the recovery continue?

✔  Commodity stock performance reversed course, notching strong gains in 2016.

✔  Agriculture stocks, in particular, may offer potential amid a global economic recovery.

✔  Regardless of short-term performance, commodity stocks may offer potential benefits in a portfolio.

After suffering a brutal 23% drop in 2015, commodity stocks rebounded in 2016, notching a 30.4% return.* Fidelity® Global Commodity Stock Fund (FFGCX) manager Joe Wickwire thinks there is the potential for that rally to continue—as long as the world avoids recession—and that agriculture stocks, U.S. exploration and development energy companies, and the select metal and mining companies look especially attractive.

What’s more, Wickwire thinks that investors may want to consider whether commodity-related companies deserve a place in a diversified portfolio. That’s because commodities have had an imperfect correlation to stocks, particularly during times of high inflation, which means that incorporating some commodities in a portfolio has the potential to provide diversification benefits.

Commodity stocks may also be worth considering because of their past performance during times of rising inflation. When mounting demand stokes broad inflation, commodity prices tend to rise, along with the prices of other goods and services. The companies in commodity-linked industries, such as those in the energy and materials sectors, benefit from the same trends as commodities and have the potential to further magnify the positive impact of rising prices by also growing earnings. As a result, commodity stocks have outperformed stocks overall and investment-grade bonds in historical rising-inflation periods, on average.

The commodity stock universe

Wickwire divides the commodity sector into three broad categories:

  • Agriculture, to feed the world
  • Energy, to power the world
  • Metals and mining, to build the world

The three categories follow similar but separate cycles. When prices rise, producers usually try to find a balance between investing back into the business to ensure longer-term viability and profitability and rewarding shareholders with dividend payouts. But if commodity producers wind up investing too much in additional production capacity as prices rise, then they run the risk of bringing on too much supply. After a while, supply outstrips demand, causing prices to fall. Companies then curtail production to cut costs, eventually leading to tighter supplies and higher prices. “There’s an old adage,” notes Wickwire. “The cure for low prices is low prices, and the cure for high prices is high prices.”

The commodity complex as a whole is currently enjoying an upcycle. According to Wickwire, from 2000 to 2011, increased demand from China and other developing countries drove commodity prices higher, as emerging markets built the roads, airports, militaries, telecommunications networks, and other infrastructure that create the foundation for modern economies. Producers across the commodity complex built out capacity as if demand would climb indefinitely. “During the tail end of that supercycle, a lot of commodity producers had overbuilt, chasing production at the expense of profitability,” Wickwire explains.

After China’s economy started slowing around 2012, prices of metals, oil and gas, and food items plummeted. Oil plunged from more than $100 a barrel to about $28, and commodities from copper to corn suffered drops of similar magnitude on a percentage basis. The declines weren’t simultaneous: The correction hit metals and mining first, then agriculture; oil’s downturn didn’t begin until mid-2014.

These corrections laid the foundation for a recovery in commodity equities, Wickwire says. “The oil industry just doesn’t work when oil sells for less than $40 per barrel, and the same goes for the farmer when corn goes below $4 a bushel, or for the miner when copper sells below $2 per pound or when gold goes below $1,100 per ounce,” he says. “When prices are that low, some investors begin growing confident that companies will have to reduce production, leading to less supply and eventually higher prices. The market tends to anticipate all this, and stock prices often rise accordingly.” Commodity stocks have broadly outperformed most other sectors and indexes since January 2016, with energy and metals and mining stocks leading the way.

Opportunities today

Wickwire says he believes these trends may continue. He notes that demand should stay healthy as long as the global economy remains generally solid, and that commodity supplies and production remain generally in check. Moreover, he says, many of the stimulative fiscal policy proposals being discussed by the new administration are likely to support higher inflation and lead to greater spending on infrastructure and defense, all of which would be good for commodity companies.

“The duration and size of the upcycle will depend on two factors: the health of the global economy and company execution,” he says. “Companies could shoot themselves in the foot if they over-invest in production—but I don’t think most management teams will be in a hurry to do that after the recent downturn.”

Given this backdrop, Wickwire thinks the most appealing parts of the global commodity equities market are shares of agriculture companies, U.S. energy exploration and production (E&P) firms, and select metal and mining companies. “The agriculture cycle has lagged the recovery in metals and mining and energy,” says Wickwire. “It hit bottom only recently, because record harvests caused supply to be too abundant. Current prices don’t justify planting much more corn, wheat, or soy—the three big global crops—so supply is going to tighten at some point, and that should help prices rise.”

Wickwire expects rising food prices, coupled with agriculture stocks’ low current valuations, to support higher prices for stocks of fertilizer, bio-seed, and food processing companies. He points to a flurry of M&A activity as another positive sign. Some current examples: ChemChina is attempting to purchase Syngenta (SYT) after Monsanto tried and failed to purchase the Swiss farm chemical and seed company; Bayer is attempting to buy Monsanto (MON); Canadian fertilizer giants PotashCorp (POT) and Agrium (AGU) are joining up; and Dow (DOW) and DuPont (DD)—chemical companies with large agriculture businesses—are considering marriage.

M&A among commodity stocks typically happens near the high and low points of a cycle, says Wickwire—but this clearly isn’t the peak, in his view. These corporate actions, coupled with the likelihood of sustained demand and restricted supply, make him bullish on agriculture-related equities, especially given the stocks’ relativity low valuations, their free cash flow potential, and the fact that agriculture tends to be the least volatile of the broader three commodity categories.

He finds U.S.-based E&P stocks attractive for a different reason: “I think that many of the world’s economies are only going to get more volatile, so the location of energy assets is going to become even more important. Companies that have a disproportionate amount of their assets and deposits in more stable markets, such as the United States, should receive a premium from the market.”

Wickwire’s fund has invested in Anadarko (APC), which produces the majority of its oil and gas in locations in Texas, Colorado, and the Gulf of Mexico. “Anadarko has demonstrated a well-thought-out management strategy that has focused on owning the right assets in the right amounts,” Wickwire says. “I think what they’ve been doing across their portfolio of assets has made the company very attractive and underappreciated. They are very good portfolio managers.”

He is quick to note that no one can pinpoint the timing of commodity cycles, so it’s important to identify a strategic allocation in one’s portfolio rather than trying to time the cycles. “But long-term investors can count on cycles turning up eventually and invest accordingly,” Wickwire says. “Meanwhile, they can benefit from the potential inflation-protection benefits that these stocks can bring to a portfolio.”

Act

  • Joe Wickwire manages Fidelity® Global Commodity Stock Fund (FFGCX).
  • Find commodity ETFs using the market tracker.
  • Find commodity stocks in the stock screener.

Plan

Learn

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. References to specific investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. This piece may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
*MSCI ACW Commodity Producers Index, as of December 31, 2016.
Joe Wickwire manages Fidelity Global Commodity Stock Fund, which invests in some of the securities mentioned in this article. As of January 31, 2017, the fund invested in PotashCorp of Saskatchewan (2.144%), Agrium Inc. (1.898%), and Anadarko Petroleum Corp. (2.027%).
Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks. The commodity industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. The fund may have additional volatility because it can invest a significant portion of assets in securities of a small number of individual issuers.
Past performance is no guarantee of future results.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
All indexes are unmanaged. You cannot invest directly in an index.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with each particular industry.
Before investing, consider the investment objectives, risks, charges, and expenses of the fund. Call or write to Fidelity or visit Fidelity.com for a free prospectus or, if available, a summary prospectus containing this information. Read it carefully.
Votes are submitted voluntarily by individuals and reflect their own opinion of the article's helpfulness. A percentage value for helpfulness will display once a sufficient number of votes have been submitted.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

795949.1.0
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.