Portfolio manager Daniel Sullivan discusses what may lie ahead for the mining, energy and agriculture sectors in 2021 and beyond.
- Balance sheets of many mining companies are strong. Limited uses of cash beyond returns to shareholders is underpinning attractive dividend yields.
- Improving fundamentals, the expected return of inflation, prospects for further dollar weakness and vaccine rollouts offer a path to higher oil prices.
- The agribusiness sector is benefiting from improving soft commodity prices, but crop production concerns remain.
- The demand for resources looks well supported by the long-term trends of increasing populations, prosperity and urbanisation, and the shift towards a digitised, electrified and fossil fuel free future.
2020 hammered home the futility of making annual predictions, but that should not stop investors from thinking ahead. As we peer into the future, notwithstanding the surprising extent of subsequent lockdowns, 2021 promises to be a year of recovery from the COVID-19 collapse of 2020.
The mining sector currently looks attractive. The balance sheets of miners are generally strong, with limited uses of cash beyond returns to shareholders, underpinning dividend yields that are attractive, particularly in an ultra-low or zero interest rate environment. The sector also offers an inflation hedge, which could be appealing as the cycle matures amidst the US$12 trillion stimulus-driven global recovery. The ongoing commodity rally now implies average earnings upgrades of 20-30% for base metals companies and 50-80% for diversified miners exposed to rampant iron ore prices. The outlook for steel and iron ore appears favourable for early 2021. With Vale, one of the largest mining groups ratchetting down expectations, we believe there will not be enough low-cost supply growth to meet incremental demand, so in our view prices need to remain above long-term averages to ensure supply remains in the market. We expect a tight iron ore market in early 2021, a copper deficit from the second quarter, a tightly balanced aluminium market in China and similarly tight palladium and coking coal markets. In a tight commodity market, supply is constrained in the face of high demand, resulting in higher prices for the commodity.
A risk worth monitoring are Chinese policies towards steel, raw materials, and renewable energy. In an attempt to counter the strength in iron ore prices, amidst a burgeoning trade dispute with Australia, Beijing’s newly released blueprint for its steel industry over the next five years includes cutting its reliance on the supply of raw materials it does not control.
The clean energy transition and its impact on materials demand should not be overlooked. This is a global, multi-year trend, driven by the growing adoption of electric vehicles (EVs) and continued investment in renewable energy generation. With many countries and corporations committing to net zero carbon emission targets by 2050, a massive transformation will be required to attain them. Commitment to these targets will lead to strong demand for copper, nickel, aluminium, cobalt, lithium, graphite and various rare earths as they are key components in EVs and renewable energy generation infrastructure. Investment in new production capacity will be required to meet the predicted demand.
No resources outlook can be complete without mentioning gold. The yellow metal is recovering from a healthy correction where prices are anticipated to rise over the longer term. The Democrats taking majority control of the US Senate provides an additional support to long-term gold prices as President Biden will be more able to pass additional stimulus. Biden will look to push higher corporate taxes, tighter regulations, increased legal oversight of tech companies and infrastructure spending, which will require increased borrowing; policies that will weaken the dollar. Alongside monetary debasement (a weaker US dollar), gold bugs may well enjoy another year in the sun.
In the oil sector, improving fundamentals, the expected return of inflation and prospects for further dollar weakness seem to offer a path to higher oil prices.
Currently the oil market appears well balanced, as demonstrated by the backwardation* [see glossary] of crude oil prices. Demand is down significantly year-on-year, vehicle miles travelled are running almost 20% below pre-COVID-19 levels and global aviation is down more than 40% year-on-year. Weak oil demand could reverse quickly as vaccines are rolled out globally. With demand set to recover over the course of 2021, the Organisation of the Petroleum Exporting Countries (OPEC) is the key variable in the market. OPEC can raise supply by several million barrels a day and maintain market balance as demand recovers. So far, they are showing decent cohesion, although cracks could easily appear in the OPEC edifice. The wildcard is Iran, where exports remain close to zero and there is some probability that these barrels return to the market in 2021 with a Biden-led rapprochement.
Despite improving oil market fundamentals, the integrated oil sector is pricing in US$50-$60 per barrel, which does not look particularly attractive unless oil prices improve in the longer term. Given the multi-decade move away from fossil fuels, it is hard to see that happening. Currently, the 2030 oil future is priced at around US$50 per barrel (as at 25 February 2021) and remains steadfast despite the increase in current oil prices. In the last year, the industry has started the reset to lower oil prices with impairments, capital expenditure cuts and dividend cuts, but still arguably needs to do more. 2020 warning bells from the acceleration of renewables investment and potential cracks in OPEC+ suggest a need to be prepared for lower, rather than higher oil prices in the medium term.
Elsewhere in energy, the market is paying close attention to gas prices, both domestic gas prices in the US and Europe, as well as international Liquified Natural Gas (LNG) markets. LNG in particular has rallied to record highs after global supply disruptions and high shipping rates conspired with recent winter weather conditions to accelerate market rebalancing.
In the agribusiness sector, the dominant theme is improving soft commodity prices, which bodes well for farmer economics and by implication for crop inputs such as fertiliser, seeds, pest control and agricultural equipment.
After a half-decade of largely weaker prices, bumper harvests, a devastating US-China trade policy rift, and most recently the coronavirus pandemic shock, staple cereals have finally broken out into what could be a sustained period of strength. We enter 2021 with plenty of crop production concerns, including dryness damaging South American corn and soybean crops, as well as winter wheat in Russia and the US. Brazil is suffering a rain shortfall, which is hitting hopes for the country’s 2021 output of soybeans, coffee, cotton and sugar too.
Similarly, the pulp and paper cycle seems to have troughed, with a recovery in both pulp and containerboard prices underway. The bioeconomy, where renewable biological resources from land and sea are used to produce food, materials and energy is growing. This concept meets the mandates of green capitalism, searching for sustainable sources of plastic, packaging and construction materials. Additionally, e-commerce penetration is positive for box demand as is a recovery in industrial activity.
We hope and expect that 2021 brings some return to normality. Resource sectors look to be leading the global recovery, with promises of more fiscal stimulus to come, further global restocking, lean inventories and no swift recovery in capital expenditure. The long-term trends of increasing populations, prosperity and urbanisation combined with the shift towards a digitised, electrified and fossil fuel free future means the global growth in consumption of natural resources should be well supported. Could we begin to see a MEGA (Mining, Energy, Gold, Agriculture) cycle?
Balance sheet: a financial statement that summarises a company's assets, liabilities and shareholders' equity at a particular point in time.
Dividend yield: dividend received on a stock relative to its price, expressed as a percentage.
Inflation hedge: an investment that aims to protect against the decreased purchasing power of money due to rising prices (inflation).
Fiscal stimulus: economic action to attempt to expand/stimulate an economy via an increase in government spending and/or lowering taxes.
Oil futures contract: an agreement to buy or sell a certain number of barrels set amount of oil at a predetermined price, on a predetermined date.
Soft commodities: commodities that are grown and cared for, such as agricultural produce and livestock, rather than mined.
*Backwardation: when a market is in backwardation, the forward price (predetermined price for delivery in the future) of a futures contract is lower than the spot (current market) price.