Investors Should Steel Themselves for Commodities Uncertainty

(July 12, 2012) — Diverging perspectives on the future of commodities—and the possible blowback from a European crisis—are clouding the way forward for institutional investors.

According to Investec Asset Management, the risk that Europe poses to commodities prices is much less important than the continued strength of the Chinese economy. Given signs that China is loosening its monetary policy and pursuing more fixed asset investment, the firm sees commodities either staying where they are or even increasing in value. In their analysis, Europe’s share of global demand for commodities such as copper and steel has greatly diminished in the past 15 years. As a result, a European recession would not depress prices as it previously had if China’s appetite remains or grows.

“Although we believe resource equity valuations appear generally attractive across the board, certain commodities equity valuations look particularly compelling in the current environment: energy, certain diversified miners, iron ore miners, certain mid-cap gold miners and fertilizer companies,” writes Investec. “Many investors remain concerned that commodity prices are flat-lining while costs continue to rise thus squeezing company margins. While this margin squeeze is true in some cases, we see numerous companies who can improve margins from higher commodity prices by growing volumes and even reducing costs.”

Although political considerations in the United States and Europe add to investor uncertainty, by and large the asset manager remains optimistic about secular commodities trends. “In the short term, persistent European financial issues should keep markets volatile, but over the medium term we believe that once China has destocked and starts cutting rates, world growth will not remain below trend and resource equities can re-rate to more normal valuations,” says Investec.

For others, however, the future of commodities looks bleak. In April, the International Monetary Fund (IMF) issued a report that predicted that commodity prices would slump during the latter half of 2012 and into 2013.

“Looking ahead, given the weak global activity and heightened downside risks to the near-term outlook, commodity exporters may be in for a downturn,” the IMF asserted. “If downside risks to global economic growth materialize, there could be even greater challenges facing commodity exporters, most of which are emerging and developing economies. Conversely, if geopolitical risks to the supply of oil materialize, oil prices could rise temporarily, but the ensuing slowdown in global growth could lead to a decline in the prices of other commodities.”