Are commodities still a raw deal for investors

The departure of Catherine Raw as co-manager of the BlackRock World Mining Trust for a job in the mining sector raises a number of questions.

Are commodities still a raw deal for investors

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Prime among them is: are you likely to make more money working for a mining company right now than you are buying its shares?

There is no doubt that the commodities sector has lagged significantly in recent years. Despite breaking through the psychological 7,000 point level on Friday, the index, of which roughly 20% is made up of resources companies, is only up 66.4% since the beginning of 2009. Over the same period, the FTSE 250, which is much less focused on commodities is up 172% and the FTSE 350 is up 77.9%.

The question now is, even if they can’t fall a great deal further, for how long are they likely to remain on the floor?

Raw and co-manager of the Trust, Evy Hambro, offer some insight in the World Mining Trust’s annual report.

The two argue that, while commodity demand held up during the 2014 year more than the falls in commodity prices imply, markets were saddled with the weight of new supply finally arriving from projects that had been in the pipeline for five years or more.

This wave of additional material “overwhelmed prices during the year and caused them to reset to lower levels, impacting long-established cost curves,” the pair said. Adding: “With input costs also falling, such as the oil price and weaker producer currencies, investors started to reassess where the new cost curves for metals and minerals production would be. This resulted in further downward pressure on metal prices especially during the last quarter.”

Looking ahead, Hambro and Raw write the demand outlook continues to remain sombre, but further underinvestment means the much of the sector is now inching toward deficit territory.

“In the near term, recent falls in metal prices might take some of the momentum out of expectations for increased dividends, but if we can look past this towards the end of the decade then we see a far more supportive market.”

Kieron Hodgson, commodities and mining analyst at Charles Stanley Securities agrees that the market is, in some areas, focusing a little too much on the oversupply side of the equation.

“Too many people have been making bearish noises about the oversupply of certain commodities and underestimating the risk of supply disruption.

“For example, in the copper market we have already seen more than 60% of the budgeted allowance of supply disruptions for the year already, within the first quarter. In a close to balanced market, such as copper, there is a strong possibility then that you head into deficit sometime during the year,” he added.
That is not, of course, to say, that now is the time to jump whole-heartedly into miners in general, but rather, he says, there are gains to be made on certain projects.

Currently, he added, he continues to like the diamond sector as it is driven by a slightly different phase of the demand cycle.

“Within the commodities complex, the diamond space remains the best place to be exposed, because demand remains strong, even with Chinese growth moderating toward more consumer-driven consumption” he says.

Differing frequencies

That said, the major problem facing investors considering commodities is that the mining cycle and the investment cycle move at different frequencies.

As Hodgson points out, investors have a much shorter investment time horizon than mining companies do.

“The iron ore capacity that is now coming on stream in Australia for example, is likely to be more than is needed for China’s needs over the next few years, but the life of mine is upwards of 50 years, so they will be able to supply not just this cycle, but the next one as well,” he says.

But, asked whether or not that means now is the time to be buying the diversifieds and he replies, “There is no need to rush, we are moving into the maturation phase of Chinese growth now and we haven’t even identified where the next upcycle is going to come from.”

Which perhaps brings us full circle. There are certainly good investments to be had in the mining sector right now, but there are perhaps better places to look right now if one is looking for short or medium returns.

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