Commodities are a very cyclical asset class, dependent on the health of the global economy. After many good years, the global financial crisis brought about commodities’ worst downturn in more than three decades.
Are things about to change for the better? First State Investments, who manage the First State Global Resources fund, thinks they could be.
Very much like the children's tale of Goldilocks and the three bears, First State Investments believe the environment for commodities is not too hot and not too cold – but just right. And here are four reasons why.
1. Debt: Management teams have been forced to reduce their debt through a combination of asset sales, cost reduction and raising equity.
2. Discipline: During the good times it is easy to become over confident and over invest. With long lead times required to bring in significant new supplies of commodities, supply started to outpace demand just when demand and prices started falling. So management has had to become much more disciplined in their spending.
3. Delivery: Management teams have also had to increase efficiency, becoming more productive while at the same time scaling back head count. Doing more with less is now a central tenet for company bosses.
4. Distributions: All of the factors above have meant that resources companies are now better placed to cover dividend payments.
JP Morgan also run a natural resources fund and they too are more positive on the asset class.
Speaking on a conference call recently, Neil Gregson, the fund manager, used the analogy of another tale – this time Cinderella: “Natural resources have gone from riches to rags in recent years, with 2015 being particularly bad. It has been the worst down turn I have ever experienced. 2016 was much better though, and low supply and higher demand suggests the next couple of years should see an improvement.
“Capital expenditure has been slashed across the board and the under-investment means supply should be lower than demand for some time. This should push prices higher. The real positive is that demand is picking up worldwide with only a couple of exceptions.
“I believe the strength of the US dollar and interest rate rises will cap the upside potential of gold, but the world is not without risk and investors will still flock to the asset at times of worry.
“The oil price should trend gently upwards. I think it will trade around the US$60 a barrel market for a while and possibly go to US$70. So I am looking at companies that can grow with oil at this level.
“Industry operating costs have fallen across the board and the scars of the downturn will keep companies much more cost conscious than they have been in the past. This will be good for shareholders as the extra margin and cash flow should result in more sustainable dividend payments. Merger and acquisitions could also increase with smaller and medium-sized companies the targets.”
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. First State Investments's and Neil's views are their own and do not constitute financial advice.