After a brief hiatus, the Diary is back and I have been asked to contribute to provide some insight on some of the pertinent issues that we are discussing at Quilter Cheviot. This will run alongside the fortnightly podcast I present with my colleague James Hughes, which is available here or on YouTube or as an audio edition on Apple Podcasts and Spotify.
Change is endemic and ever present but one can’t help but feel the world has been in a constant state of flux since the outbreak of the pandemic in 2020. Up until then, the post-2008 environment had been characterised by low inflation, low economic growth and low interest rates. And on the whole, it was a kind decade or so for investors (albeit with few speed bumps along the way), with equity and bond markets providing very respectable returns.
The lockdown measures introduced in 2020 and the resultant fiscal and monetary stimulus, allied to geopolitical instability, has ultimately unleashed a very different world. The cost of money has reset dramatically with interest rates going from 0.5% or thereabouts to over 5% in the UK and US within the space of two years as central banks have sought to quell inflation. The consequences are profound and continue to be felt in financial markets and the real economy. One particular area impacted, and an area I want to touch upon here, is commodity markets.
Commodities as a group have not been a profitable place for investors over the last 15 years as the chart below of the Bloomberg Commodities Index illustrates. In fact, in nominal terms, commodity prices are where they were almost 30 years ago.
Source: FactSet, 25th October 2023. Past performance is not a reliable indicator of future results.
The last 10 years in particular has been characterised by low prices, cuts to capital expenditure by the big energy and mining producers and weak returns for investors. As a farmer’s son, I know only too well the classic commodities cycle, broadly characterised as follows:
Commodity markets exhibit cyclicality, which exacerbates their highs and lows. This can be caused by a variety of reasons including changes in consumer behaviour, technological breakthroughs, geopolitical tensions and economic growth. After a period in the doldrums culminating in very weak prices in early 2020, the reopening of economies from lockdown restrictions alongside the Russian invasion of Ukraine saw a strong recovery in the oil price (other areas such as agriculture commodities also increased markedly).
The impact of weak investment by the integrated energy companies (such as BP, Shell and Chevron) over the last few years has handicapped their ability to increase output but OPEC, the oil “cartel” led by Saudi Arabia, have begun to play a more prominent role once more. First, OPEC sought to use its spare capacity to moderate the price surge in the wake of the Ukrainian war but more recently production cuts have been the aim, intended to prop up a sliding oil price due to concerns of softening global demand.
There has long been calls for peak oil – the point at which global crude oil production will peak and subsequently begin to decline – but despite growing opposition to fossil fuel use, its demand remains robust. Should the energy transition take longer than hoped to occur a prolonged reliance on oil, coupled with reduced future supply will push prices higher.
As well as the energy market, the move away from fossil fuels as part of the energy transition is a key longer-term theme for base metals such as copper and iron ore. The pandemic response has heralded an acceleration in political interest and there is significant investment going into this area right across the world. This presents investors with opportunities as well as challenges, opening investment opportunities in areas such as solar and offshore wind, albeit with the risk of too much “hype” which would potentially lead to unprofitable investments. Share prices in the nascent “clean energy” sector have been on a rollercoaster ride as the chart of iShares Clean Energy ETF illustrates:
Source: FactSet 28th November 2023. Past performance is not a reliable indicator of future results.
Despite this, copper remains a key ingredient in the energy transition. A single electric car needs a lot more copper than a vehicle with a conventional internal combustion engine and offshore wind turbines need many miles of copper wire to transport the electricity to the grid, underpinning strong demand growth over the next decade as countries accelerate their energy transition plans.
There are, however, challenges on the supply side. These include declining ore grades, geopolitical unpredictability in key copper-producing regions and the difficulties involved in building new mines. A recent article in the FT highlighted this, with the following noteworthy chart:
Copper prices, and those for wider commodities for that matter, will continue to retain cyclical properties due to their sensitivity to the economic cycle. But with the world is seemingly becoming a more fractured and dangerous place, and with the growing urgency of the energy transition, interesting longer-term opportunities have arisen.
James and I discussed all matter commodities and energy transition on a recent Taking Stock – After The Bell podcast with Quilter Cheviot’s Materials analyst, Jamie Maddock, which may be of interest if you want to hear a bit more about this area.
In the meantime, if you do have any questions then please do get in touch.
This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination marketing communications. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it
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