Commodities remain undervalued
The COVID-19 pandemic and ensuing recovery has had both acute and chronic impacts on people, health systems and economies. The unprecedented scale and ongoing negative impacts of global disruption is still playing out in the financial and real economies around the world.
Considering the extraordinary central bank policies initiated to sustain economic and further drive inflationary growth, it is difficult to conceive of scenarios where commodity prices fail to rise in the next decade, particularly considering the relative lack of supply side investment over the past decade.
New mine development projects take decades to de-risk prior to becoming new mines, a situation that depends on rising commodity prices to deliver positive risk adjusted returns for capital providers. Considering the prolonged commodity market downturn, this positive commodity price signal has been absent until very recently. All the while, existing mines have grown older, deeper and generally more expensive to run.
In contrast to long timelines for new commodity supply, global just-in-time manufacturing assumes that primary inputs will be available as and when needed throughout the value chain. This is not always the case as demonstrated by high commodity prices during cyclical peaks and/or significant disruptions to globalized supply chains.
The disconnect between commodity prices (supply) and ultimate commodity demand (industrial production) can be highlighted by the change in relative value of the S&P 500 equity index and underlying commodity prices. As represented by the turn in the Bloomberg Commodity Index, the early recovery in the mining sector has started.
- 5.6xS&P500 v Bloomberg Commodity Indexreal assets must increase to support global growth
All productive growth is dependent on transforming primary inputs into real assets and physical goods. The valuation disconnect presents what we believe to be an attractive countercyclical opportunity for investors willing to position portfolios toward real assets. The current differential between financial assets (S&P 500 index) and real assets (commodity indices) must eventually converge to support sustainable global growth. In the meantime, real assets will provide a hedge against rising inflation, as the gap is closed.
Bloomberg Commodity Index vs. S&P500 Total Return
As of 1 July 2022
This information should not be deemed to be a recommendation of any specific commodity, company or security. This chart includes forward-looking information, and we caution you that such information is inherently less reliable. Actual performance will vary due to a variety of factors, including general economic conditions. Any projections have been prepared and are set out for illustrative purposes only, and do not constitute a forecast. Any projections or opinions are current as of the date hereof only. The statistical information provided herein has been supplied for “informational purposes” only and is not intended to be and does not constitute investment advice. Neither RCF nor any independent third party has independently audited or verified this information. Past performance is not indicative of future results. RCF disclaims any and all liability relating to such information, and no representation or warranty is made, expressed or implied, as to the accuracy or completeness of the information provided in this presentation.
All information in this insight is as of June 14, 2022, unless otherwise noted, and is based on information available at a certain point in time. All information should be assumed as subject to change; updated information will not be provided.