A quick glance at recent headlines would lead a reasonable person to assume that this year’s big losers are Greek and Chinese stocks. Yet, despite all the furor in the news, the Athens Stock Exchange is down less than 5% year-to-date, while the Shanghai Composite remains up more than 10%, according to Bloomberg data.
The real damage has been in the commodity complex. Through late July, year-to-date crude oil prices were down around 10%, platinum prices were off nearly 20% and coffee prices were down almost 30%, Bloomberg data shows. Based on the Bloomberg Commodity Index of 22 commodities, the overall complex is now trading at a 13-year low. Several factors account for the sell-off.
Slowing global growth
So far, 2015 is shaping up to be another disappointing year. The International Monetary Fund (IMF) recently lowered its full year estimate for global growth to a bit below last year. In the United States, 2015 gross domestic product (GDP) growth estimates have fallen by nearly a full percentage point since February, according to Bloomberg data. Slower growth negatively impacts cyclical commodities, like energy and industrial metals. As economic activity decelerates, so too does demand for these commodities.
Expectations for a Federal Reserve (Fed) hike
While growth is disappointing, it’s arguably still strong enough to justify an initial Fed hike later this fall. Expectations for tighter monetary policy are impacting commodities in a few related ways. Central bank divergence, i.e. the Fed hiking while most other central banks are easing, is likely to push the dollar, already up 8% year-to-date, higher. In addition, certain commodities, notably precious metals, are being negatively impacted by rising real rates.
While this issue is more idiosyncratic, it has been one of the key factors hurting energy prices, particularly crude oil prices. Despite a precipitous decline in the U.S. rig count, greater efficiency has allowed U.S. domestic production to rise by roughly 500k barrels since the end of 2014, according to Bloomberg data. In addition to still-robust U.S. production, investors have had to contend with rising supply from the Middle East as well as with the prospect of even more supply from that region. With the pending Iran deal, other Middle Eastern producers appear to be ramping up production in an effort to defend market share. Thanks to rising production from Saudi Arabia and Iraq, Organization of Petroleum Exporting Countries (OPEC) production is up more than 1.5 million barrels per day since the start of the year, according to Bloomberg data.
None of these factors are likely to change in the near term, meaning that commodity prices are likely to remain under some pressure. This suggests that for investors, the better opportunity may be in the companies that produce the commodities, rather than in the commodities themselves. Many of these stocks already reflect quite a bit of bad news. For instance, based on my calculations using Bloomberg data, the U.S. energy sector, as measured by the S&P 500 Energy Index, is currently trading at roughly 1.60x book value, a 40% discount to the broader market and in line with lows seen in 2009. Meanwhile, metal stocks are selling at an even greater discount, my calculations show, with the S&P Metal and Mining Select Industry Index trading at close to book value and barely 11x earnings. Finally, potential supply cutbacks — most recently, copper producer Freeport-McMoRan Inc. said it’s mulling cutbacks — will eventually help constrain supply and help stabilize prices.
But for now, with commodity prices still falling and global growth slowing, it may be too early too aggressively buy commodity producers. Still, investors looking for bargains in an otherwise stretched market should keep an eye on these stocks.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.
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