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Hard and Soft Commodities Rewarding Brave Investors

Metals are being supported by industrial demand and soft commodities such as coffee and lumber are being driven by global trends such as population growth

Holly Black 29 August, 2017 | 8:55AM

Timber worker in China

The FTSE All Share Basic Materials sector has been one of the poorest performers of recent years. Over the past decade it has produced an annualised return of just 1.6% and a total return of just 16.9%. But some experts are starting to feel more optimistic about the sector, which includes metals and soft commodities such as timber and coffee.

A glut of commodity supply, a fall in demand in China and the advent of fracking, along with a prolonged global financial crisis, have given companies in the sector an incredibly difficult time over the past few years. According to Morningstar data, a £10,000 investment a decade ago would be worth just £11,689 today, and investors would have had to endure a rollercoaster ride over that period as the index slumped 30% only to soar 31% the next.

Businesses have had to undergo a major overhaul in order to survive, cutting capital expenditure, paying off debt and strengthening their balance sheets. And after many years of pain, some investors think we could be entering a new commodity bull market. Over the past 12 months the index – which includes metal miners, speciality chemicals companies and building materials businesses – is up 40.6%.

Olivia Markham, co-manager of the BlackRock World Mining Trust (BRWM), said: “What makes us optimistic is that firms have cut their costs by around 50%, sold off assets and brought in new management teams which are more disciplined and shareholder friendly.”

Markham, whose fund has returned 32.2% over the past year, is focusing on the copper industry, where demand is being boosted by the use of the industrial metal in electric cars. The copper price has surged around 46% over the past year and fund holdings such as Peru-based miner Cerro Verde tap into this trend.

Meanwhile James Luke, metals fund manager at Schroders, thinks the gold price could be about to rise. The yellow metal has historically done well at times when there is uncertainty and, with growing tensions between the US and North Korea and the UK negotiating Brexit, nervous investors could flock to the asset as an insurance policy.

But investors interested in the sector need to look east. “Ultimately, what is happening in China is driving commodity prices. Even if demand from the region is strong other concerns about a slowing economy or rising debt in the country could hit sentiment,” Markham warned.

Those who are still cautious about the outlook for the sector might consider alternative parts of it. Soft commodities such as coffee and lumber are being driven by global trends such as population growth and the need to feed more people and provide more housing.

Christoph Butz, co-manager of the Pictet Timber fund, said: “This is an area of continuous growth and unlike many commodities which are, ultimately, finite, as long as timber is managed sustainably it is renewable.”

Butz, whose fund is up 22.5% over the past year, argues that commodities such as timber can be a useful diversifier for materials investors because it is not linked to other commodities, instead it is more closely tied to the housing and construction markets.

As well as building, demand for timber pulp is rapidly increasing because of internet retailers needing strong materials for packaging. Indeed, the price of lumber is up almost 19% over the past year.

But, just as with other materials, there are risks around demand in China and politics, with Trump’s protectionist policies expected to hit the Canadian lumber industry. Yet the long-term trends which are driving commodities look set to continue: populations are growing, and metals and materials will be needed to build houses and cars and to supply energy. Markus Stadlmann, chief investment officer at Lloyds Bank, said: “We are getting to the end of a supply glut problem in energy markets and, at some point over the next 12 months, I expect commodity prices to reflect this.”

But investors need a long-time horizon to ride out the ups and downs this sector so often experiences; the fortunes of the materials industry tend to be incredibly cyclical.

For now, however, debt is under control and capital discipline has improved. Experts think shareholders will soon feel the benefits of that in the form of dividends and share buybacks. Sutton thinks that pressure from activist investors should ensure that management stick to their newfound strategies - for now at least.

Markham said: “There has been a change of behaviour in this sector and that’s important – it is staying disciplined, generating cash and, compared with other markets, is still trading at a discount.”

 

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
BlackRock World Mining Trust plc380.25 GBX-0.20
About Author

Holly Black  is a freelance journalist specialising in investments and personal finance