During the last so-called supercycle, which occurred during the period of the late 1990s to 2008, commodities produced extreme returns (e.g. Brent moved from USD 10 to 140) fuelled by the rapid growth in China. The situation today is not comparable, as growth is occurring at more sustainable at levels. "This strengthens our positive outlook for the future of commodities. Overall, the dynamics of commodity markets now are much more balanced and that makes the universe more investable and attractive", says Thomas Rutz, fund manager at MainFirst.
The second half of 2018 was marked by increasing fears of a global slowdown, a stronger dollar and a slowing Chinese economy, which accounts for a significant percent of global commodity consumption. Furthermore, the US-China trade dispute has particularly contributed to lowering future growth expectations. These reasons have been a drag in the performance of all cyclical assets and of course the commodity sector as well.
Rutz adds: "We are overall constructive on the commodities markets over the coming 12-18 months. Our view is that the global economy, despite the slowing, is still in a healthy state and we do not expect a recession in the next 12-18 months. Our base case scenario is the continuation of the current business cycle but with weaker global growth closer to the trend and with EM growth increasing compared to developed markets. We expect positive developments on the trade front between the US and China and that the Chinese measures of easing will start to have an impact on the real economy at the beginning of the second half of 2019."
The Chinese government has already responded appropriately and is stimulating the economy by easing monetary policy, boosting bank lending and cutting personal income tax. As such we are constructive on the commodity sector and particularly cyclical commodities such as base & industrial metals.
We currently like copper and nickel, which are used in batteries and electric vehicle wirings and are going to benefit from the increase in the number of electric cars in the future. Moreover, we believe that current prices do not fully take into account the structural increase in the future demand.
We also like exposure in oil through low cost small producers. Oil has undergone a significant correction since October 2018, bottoming in December at 43 USD/barrel and 50 USD/barrel for WTI and Brent respectively. Our view is that levels below 50 USD/barrel and 60 USD/barrel for WTI and Brent are unsustainably low. At such levels, US shale companies are burning cash and the room for further increase in leverage is limited as the impact of the 2014-2016 oil bear market is still visible on US drillers. OPEC already cut 1.3 million barrels/day from the market, which we believe should be enough to achieve balance in the market given the continuation of current demand dynamics.
"We view any issue on the oil market as primarily a supply side problem and do not believe that OPEC will repeat their failed strategy of 2014-2016 given the tighter fiscal room of Saudi Arabia and the rest of the MENA countries. We see Brent trading at a range of 65-70 USD/barrel, which should allow our companies to generate solid EBITDA and FCF", continues Rutz.
Despite our constructive macro outlook, we think that volatility is here to stay. Given that and our expectations for a weaker dollar and easier monetary policy in US, we think that investors should look to add gold positions as a diversification trade.