Markets look for a better deal from raw materials

Investors know all too well that following the crowd – the consensus – is usually a quick way to the poor house. Meanwhile, going against the herd can often bring the best long-term results, even if the wait for market opinion to turn and go your way can often be longer than expected and therefore uncomfortable. 

At the moment the one asset class which seems to be attracting next to no attention is commodities. A meeting with BlackRock’s multi-asset fund team earlier this month flagged how raw materials seem to be off many people’s radar. In stark contrast to say 2007 to 2010, when talk of a supercycle was rampant, BlackRock’s deputy chief investment officer on the multi-asset team, Pierre Sarrau, noted his firm’s proprietary indicators were flagging Japanese equities and European credit as potentially crowded trades, while energy and soft commodities were seeing depressed positioning, weak flows and poor price action.

A quick look at performance (in sterling terms) for the key asset classes in 2015 would appear to support Sarrau’s assertion. Commodities ranks just fourth of five.

Commodities are underperforming again in 2015

Source: Thomson Reuters Datastream. Performance figures in sterling terms, to 15 June 2015.

A brisk look across 24 individual raw materials (energy, precious metals, industrial metals and softs) reveals just seven have offered positive returns to any intrepid investors this year (and three of the gains come to less than 1%).

Very few commodities have registered price gains in 2015

Source: Thomson Reuters Datastream. Performance figures in sterling terms, to 15 June 2015.

Oil’s position at the top of the tree is one up for any contrarians out there after its precipitous collapse in 2014, even if lofty US inventories, the onset of summer in the Western hemisphere, Saudi Arabian determination to tackle the threat posed by American shale and soft major developed economies all question whether crude can maintain its run. Moreover, you would have needed a crystal ball to spot cocoa as a winner, or at least particular insight into the weather in Ghana, where weak rainfall has affected the crop.

Such unpredictable factors may persuade many investors to leave commodities well alone, especially as it can be argued that taking a long-term view on rising raw material prices is to bet against human ingenuity. History suggests humankind has a good record of increasing output in ever-more innovative and cost—effective ways, with fracking and shale the latest case in point. With food wastage so high it can also be argued that distribution is the problem, not supply.

Nevertheless, commodities can potentially provide useful portfolio diversification and contrarian clients may be tempted by five years of relative underperformance. In this case, the providers of picks and shovels rather than the raw materials themselves have a habit of doing best during cyclical upturns at least on a stock-by-stock basis, if history is any guide. Equally, broad exposure to commodity-related stocks via a fund, investment trust or exchange-traded fund may be preferred, to manage risk, while braver souls may look toward an exchange-traded commodity (ETC) which tracks the performance of just one specific commodity. There is no shortage from which to choose. Finally, multi-asset funds can also bring commodity exposure and help provide diversification in their own right.

For the tables below, those for OIECs and investment trusts refer to equity plays on commodities, the table for ETFs instruments which directly track the performance of the underlying raw materials, although the small size of the passive funds involved does erode some of the value of the comparison.

Best performing Global Natural Resources funds over five years

OEIC	ISIN	Fund size£ million	Annualised five-year performance	Dividend yield	Ongoing charge	Morningstar rating
Pictet Timber I dy GBP	LU0448837087	357.9	7.5%	0.6%	1.23%	*****
Baring Global Resources I GBP (Acc)	IE00B4V6GM81	292.8	-4.2%	n/a	1.26%	*****
First State Global Resources B (Acc) GBP	GB0033737767	404.4	-6.7%	1.7%	0.87%	***
JP Morgan Natural Resources B (Net Acc)	GB00B1YXDT10	744.4	-11.2%	0.7%	1.18%	**
BlackRock Global Funds - World Mining D2	LU0252968341	3,217.8	-11.9%	n/a	1.31%	**

Source: Morningstar, for Sector Equity Natural Resources category, as of 16 June 2015
Where more than one class of fund features only the best performer is listed.

Best performing commodities and natural resources investment trusts over five years

Investment Trust	EPIC	Market cap£ million	Annualised five-year performance	Dividend yield	Gearing	Ongoing charge	Discountto NAV	Morningstar rating
El Oro	ELX	35.5	48.5%	6.7%	55%	2.23%	-33.0%	***
BlackRock Commodities Income	BRCI	89.8	-2.5%	7.2%	0%	1.46%	2.1%	****
BlackRock World Mining	BRWM	527.0	-9.7%	7.1%	13%	1.40%	-12.2%	**
City Natural Resources High Yield	CYN	64.0	-10.5%	6.0%	23%	1.70%	-26.6%	***
New City Energy	NCE	9.9	-14.2%	11.1%	8%	2.84%	-19.5%	*

Source: Morningstar, for Commodities and Natural Resources category, as of 16 June 2015

Best performing commodities exchange-traded funds (ETFs) over five years

ETF	EPIC	Market cap£ million	Annualised five-year performance	Dividend yield	Total ExpenseRatio	Morningstar rating	Replicationmethod
db X-trackers DBLCI - OY Balanced UCITS ETF 2C (USD)	XBCU	272.1	-2.0%	n/a	0.55%	n/a	Synthetic
iPath S&P GSCI Index TR (DE) ETN GBP	SPGS	2.2	-2.0%	n/a	n/a	n/a	Synthetic
iPath DJ-UBS Commodity Index TR (DE) ETN GBP	DJUB	0.2	-2.3%	n/a	n/a	n/a	Synthetic
ETFS Longer Dated Ex-Energy ETC (USD)	EXEF	0.1	-2.9%	n/a	n/a	n/a	Synthetic
ETFS Ex-Energy ETC (USD)	AIGX	0.5	-3.7%	n/a	n/a	n/a	Synthetic

Source: Morningstar, for Commodities Broad Basket category, as of 16 June 2015

Best performing GBP Aggressive Allocation (multi-asset) funds over five years

OEIC	ISIN	Fund size£ million	Annualised five-year performance	Dividend yield	Ongoing charge	Morningstar rating
Smith & Williamson Revera UK Dynamic Founder GBP Acc	GB00B3BSKJ23	76.1	15.4%	1.5%	1.35%	*****
Threadneedle Monthly Extra Income ZNI Inc	GB00B8BZ3226	388.6	13.0%	4.2%	0.73%	*****
Consistent Practical Investment A Inc	GB0006982457	71.6	12.9%	3.6%	1.15%	*****
Cavendish UK Balanced Income B	GB00B52JT570	42.6	12.5%	5.1%	0.61%	*****
FP Russell International Growth Assets Fund C Acc	GB00B4KHXP47	241.2	12.5%	0.6%	1.09%	*****

Source: Morningstar, for GBP Aggressive Allocation category, as of 16 June 2015
Where more than one class of fund features only the best performer is listed.

In the raw

Commodities’ fall from grace as an asset class has not been sudden. The next graphics summarise the performance of global equities, global sovereign bonds, global corporate bonds, global high yield debt and commodities over the last ten years, by ranking their performance from one (the best) to five (the worst) in that grouping. As can be seen commodities have done badly for five years on the trot, partly as a result of disappointing economic growth in a deleveraging world and partly due to the huge amounts of fresh supply brought  on (notably in mining) in response to the boom. New mines take five, ten years or more to hit their stride and production is rising now, forcing many hole-diggers to ramp up output whether they like or not, as shutdowns are expensive and there are debt interest and other bills still to pay.

Commodities have lagged other asset classes for five years

Source: AJ Bell Research, Thomson Reuters Datastream

Compare this to equities, which seem to be on a hot streak.

Global equities have had a good run since the lows of 2009

Source: AJ Bell Research, Thomson Reuters Datastream

Meanwhile the three debt options (of varying degrees of risk, quality and therefore potential return) have moved from top to bottom and back again. Intriguingly, junk debt has been the most consistently strong performer, with sovereign debt the most volatile, perhaps as a result of clients’ quest for income and the effects of central bank quantitative easing (QE) programmes respectively.

High yield debt has generally done better than …

Source: AJ Bell Research, Thomson Reuters Datastream

…both sovereign debt (which has been surprisingly volatile) ….

Source: AJ Bell Research, Thomson Reuters Datastream

Meanwhile, corporate debt has sat somewhere between the two in our ‘rankings’.

…and investment grade corporate debt

Source: AJ Bell Research, Thomson Reuters Datastream

Supercycle snuffed out

Talk of a permanent upcycle has long since faded away, as the multi-year performance of the Bloomberg (formerly Dow Jones-UBS) commodity index suggests.

Commodities supercycle looks puffed out for now

Source: AJ Bell Research, Thomson Reuters Datastream

‘Doctor’ Copper’s woeful showing only adds to concerns about the health of the asset class. The industrial metal is not run by a cartel, unlike say oil, and is used widely in construction and manufacturing so in many ways its price is as good a guide as any to what is really going on.

Doctor Copper remains in questionable health

Source: AJ Bell Research, Thomson Reuters Datastream

At least supply-side discipline in the West, in the form of capital expenditure cuts and a greater focus on return on capital employed may be offering some support to oil. Meanwhile, mining executives also appear to be adjusting to the new reality, too. A new report on the industry from consultants PWC, entitled. The gloves are off reveals that capex at the top 40 miners worldwide fell 20% to $103 billion in 2014, adding that a further 13% cut to around $90 billion in planned for this year. This offers some hope for the future, and PWC suggests nickel, aluminium, copper and zinc are seeing tighter supply, even if coal and iron ore are still oversupplied, especially the latter, where big players like Rio Tinto and BHP Billiton seem prepared to drive prices lower to try and knock-out smaller or less efficient producers.

One notable feature of the table on investment trusts in particular is the yield on offer from miners. PWC’s capex cut forecasts provide some comfort here, but those figures need to be scrutinised in the months ahead. The consultant’s report reveals that net debt to equity at the top 40 miners is a manageable 43%, even if four firms have net debt/EBITDA ratios exceeding four-to-one. Worse, they are all state-owned or state-backed so they won’t be going bust and their ongoing supply could hamper a broader market recovery.

Of greater import still is the skinny dividend cover on offer. PWC’s aggregate earnings cover shareholder dividends by just 1.1 times at the miners, with fresh borrowings often a source of funding for these payments, a practice which the consultant calls “unsustainable in the long term”. Income seekers need to proceed with caution and ensure they or their chosen fund managers are doing their homework here.

Shiny happy people

To conclude this look at commodities, it is worth noting one raw material in particular drew hardly attention at all during the recent AJ Bell Investcentre roadshow – gold. The precious metal peaked at $1,920 an ounce in September 2011 but after a sharp retreat has largely paddled sideways – in dollar terms. But look at its performance in yen since 4 April 2013, the day when Tokyo’s Prime Minister, Shinzo Abe, and Bank of Japan Governor Haruhiko Kuroda announced Japan’s huge Quantitative Easing programme.

Gold has done in badly in dollar terms over the last two years….

Source: AJ Bell Research, Thomson Reuters Datastream

….but very well in yen….

Source: AJ Bell Research, Thomson Reuters Datastream

….and euros…

Source: AJ Bell Research, Thomson Reuters Datastream

….but poorly in sterling.

Source: AJ Bell Research, Thomson Reuters Datastream

Gold has also done solidly enough in euros and badly in sterling, so at least a theme can be discerned. The precious metal is doing well where central banks are running QE at full throttle, creating electronic money out of thin air and less well where QE programmes have been called to a halt (at least for now). 

In this respect, gold bugs will argue it is doing its job, as a store of wealth and source of protection against the debasement of ‘fiat’ currency. It will be therefore interesting to see what gold does if Europe stops its QE scheme on time in September 2016 and if Japan ever presses the ‘stop’ button (not that the Bank of Japan seems inclined to do so at the moment). It will be equally interesting to see what it will do if the US and UK ever rate interest rates – in theory it should fall – although they seem in no hurry either. The battle lines between fans and haters of gold therefore remain as clearly drawn as ever.

Russ Mould,
Investment Director, AJ Bell