By Dan Denbow, CFA, Senior Portfolio Manager of Equity
The notion of synchronized global economic growth amid low interest rates is fueling the current “risk-on” rally that’s propelling stocks to all-time highs. The Wall Street Journal ran a story this week illustrating the ongoing lack of equity volatility: Through Tuesday, the Standard & Poor’s 500 index has gone a record 243 straight trading sessions without dipping at least 3% from recent peak to trough.
The macro factors driving stocks are having a more complicated impact on natural resources – some areas are catching what may be a prolonged tailwind, while others are facing stiffening headwinds. On top of that are governmental and market uncertainties that are also affecting prices of commodities and the share prices of companies that produce them.
Here’s a brief rundown on key components of the commodities market:
CRUDE OIL: The price of oil has appreciated roughly 20% since bottoming in late June, though it’s still down 8% year to date. The price recovery is due in large part to the steady reduction of a massive supply glut that had persisted for a couple of years. OPEC and non-OPEC producers have pledged to constrict their output through at least next spring to try to bring supply and demand into closer balance.
The performance of energy stocks tends to be leveraged to the oil price, but the equities are not fully sharing in the recent rally. Since the 2017 oil price bottom in June, most of the large integrated U.S. oil and gas companies are up in the low double digits, exploration and production companies are up only 5% and oil-field service companies less than 1%.
We think among the reasons the energy stocks are lagging the commodity is a lack of faith that the current price upswing has much more room to run. Oil prices in the $50s encourages U.S. shale players to boost production and may also inspire OPEC countries to exceed their agreed-upon quotas – this could be the seeds of a new oversupply problem.
Another consideration is the U.S. dollar, which has been appreciating since early September. Oil is priced in dollars, so continued strengthening of the greenback could crimp demand.
PRECIOUS METALS: Gold also tends to have an inverse relationship with the dollar, so lately gold has struggled. Its 2017 peak of more than $1,350 per ounce came in early September, after a weak jobs report and the North Korea nuclear threat pushed investors toward safe havens.
The dollar hit its low for the year at the same time, and since then, it has appreciated by close to 3% and gold has retreated to around $1,275. North Korea worries have been replaced by dollar-positive concerns: the prospect of a December interest rate hike and the possibility of U.S. tax reform that stokes economic growth. The trend for other precious metals (except palladium) has largely tracked gold.
Gold is still up 9% YTD, which tops the 6% price gain for gold-mining stocks. Along with the tough macro environment, gold output is down this year due in large part to depleted reserves and governmental disputes. Lack of investor faith seems to be an issue here, too. Enhancing profits via cost-cutting is largely played out, so the gold-mining stocks need top-line growth to perform.
INDUSTRIAL METALS: Global economic growth has been a boon for industrial metals. Copper is up more than 45% year over year – earlier this month, it reached its highest price in more than three years. Iron ore has appreciated 20+% over the same period (though it is well down from its September peak), and cobalt, lead, zinc and nickel have also posted sizable gains.
Demand from China has been a key factor – its copper imports in September were nearly 20% higher than a year earlier, and it has also been restocking iron ore. Copper supply disruptions from Chile and Indonesia, and expanding production of electric vehicles, are also supporting prices.
Share prices for industrial metals producers strongly outperformed the S&P 500 early in 2017, but they have since faded and are now in line with the broader index. Valuations are slightly higher than the index. The mining stocks tend to be highly correlated to the underlying commodity prices, so going forward, Chinese demand should continue to be influential.
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