Commodity prices and Commodity companies have been very much in the focus in past last years, first due to a strong rally over several years and then due to an extreme sell-off losing the long-year gains within less than 6 months. Commodity prices have collapsed since Mid 2008: Base Metal prices have fallen by 60% since March 2008.…
The Oil price has fallen by 70% between July 2008 and November 2008. But for the last 3 months the oil price has somewhat stablised and moved volatile sideways. Our oil analysts believe a convincing floor in oil prices may require stability in global equity markets, a reduction in asset market volatility, another round of OPEC production cuts and a resumption in US and hence world growth. Main risk to commodities prices and the performance of the Basic Resources sector is that recession lasts longer than expected and that the Emerging Markets, especially China, slow down stronger than expected. Also disappointments with regard to the implemention of the stimulus packages which have been announced by many countries could be a risk for commodity prices.
Besides the oil price, Industrial metals and the equity sector Basic Resources have stabilised over the last 3 months. YTD, Basic Resources is the best performing equity sector with 2%. The equity sector Basic Resources has been the best performer from end 2005 to May 2008 with a performance of 100%. Since the peak in May 2008 the sector has fallen by 73%, mainly driven by the global recession. Due to the extreme performance history Basic Resources has by far the highest Beta of all sectors with 1.6 The fundamental reason for the commodity rally between 2002 and 2008, the long-term demand growth in emerging markets is still in place. The long term trend is currently overshadowed by a cyclical demand decline where the length and strength of the cyclical decline is quite uncertain. Some emerging markets, including China, may cope with the crisis better than the developed world. Massive government debt issuance may push commodity prices higher without boosting industrial output. Fears of increasing inflation in the longer term could also be a trigger for rising commodity prices. In the longer term, Emerging Markets commodity demand growth is likely to recover and to be supported by ongoing urbanisation, infrastructure build-up and increasing mobility demand.
Within the European DJ Stoxx Basic Resources sector Mining companies have by far the largest weight with 74% of the total sector, Steel and other metal companies have 21% weight and Paper companies account for 5% weight. Whereas the Mining companies are mostly global players, the Steel companies are mostly focussing on Europe. For Base Metals, Iron Ore and Coal the low price level have triggered the reduction of mining capacities and the cancellation of new projects. Mining companies reduce their work force and their production costs. Reduced production volumes could well trigger price increases, if the economic outlook brightens a little bit, especially in China. For the Mining companies, the future development of commodity prices is absolutely key and China represents 25-50% of world demand for the majority of commodities. Therefore, the economic development in China is especially important for many commodity prices and for the Basic Resources sector. Our economists expect Chinese GDP growth of 7.0% for 2009E and further slowing in 2010E to a GDP growth of 6.6%. This takes into account a stimulus package of US-$ 586 billion over two years, thereof US-$85 billion would go to helping firms improve technology and energy efficiency; US-$54 billion to rural infrastructure; US-$219 billion to rail links and highways; US-$145 billion to reconstruction in the earthquake-hit Sichuan region. The recession in most Western countries makes Chinese plans and activities even more important for the Mining companies.
China may currently see investments in Mining companies as an attractive hedge against rising commodity prices going forward. China has huge FX reserves of US-$ 1.95 trillion and only a low share is invested in equities so far. China’s reserves rose by US-$ 356.2 billion in 2008, US-$ 461.9 billion in 2007 and US-$ 247.3 billion in 2006. In Feb 2009 Chinalco, or Aluminium Corp. of China, has acquired a 9% stake in Rio Tinto for US-$ 19.5billion. China’s top aluminium maker agreed to pay US-$ 12.3 billion for stakes in Rio’s key iron ore, copper and aluminium assets and US-$ 7.2 billion for convertible notes that could potentially double its equity stake in Rio from the announced 9% to 18%. In H2 2008 many companies with high debt levels performed badly due to rising credit spreads and this includes some large Mining companies. The improvement of the capital base of some large mining companies is one more reason to be positive for the sector. Our analyst has recently upgraded Xstrata, one of the major Mining companies to Buy (395.8p).
Overall, commodity prices and commodity stocks could be among the first assets to benefit over the next months from hopes of some economic recovery in 2010 and from the implementation of stimulus packages. Commodity stocks could also benefit from the improved capital base. So after the stabilisation of commodity prices and commodity stocks we see clearly more upside chances than downside risks. Therefore we buy for 15% the ETF “db x-trackers DJ Stoxx Basic Resources” and for 15% the ETF on the Commodity index “db x-trackers DBLCI –OY balanced”. The highest weight in this Commodity index is Oil with 47% and Gold with 16% (for details on the commodity index see Appendix).
Trading portfolio
In addition to the two new ETFs, we continue to own the ETF “db x-trackers DJ Stoxx600 Banks” as another high Beta sector. The ownership of 2 high beta sectors expresses our view of a continuing market recovery in the short to medium term. In our view, most investors are still underweight the banking sector. Most of the expected unfavourable news flow in 2009 seems to be priced in for the Banks. Banks have performed well over the last week. We continue to see a good chance that Banks continue to recover and outperform the market in the next months. This idea is based on very active governments and central banks, which support the banking sector as a whole and help to improve the liquidity position for banks. Risks to the performance of Banks include a longer than expected recession, new major write-downs on illiquid assets, a higher than expected number of company defaults during the recession and an escalation of the problems in Eastern Europe. Many West European banks have significant exposure to Eastern Europe.
We also keep the “db x-trackers iTraxx Crossover 5Yr TR Index ETF” in our portfolio. Credit spreads are still cheap in our view and it seems that the credit market has already priced in a deep recession more than appropriately and we continue to expect a normalisation of credit spreads in the longer term. For details on the iTraxx Crossover 5Yr TR Index see our note “ETF: Ideas and Flows” from 8 December 2008. The trading portfolio below reflects the changes discussed above. The portfolio targets absolute return and has the EONIA index as benchmark. Risks to the performance of iTraxx Crossover 5Yr TR Index include a longer than expected recession and a higher than expected number of major company defaults, especially of companies included the Crossover index portfolio.
The strong reduction in central bank rates has led to a considerable decline in money market rates. Accordingly, money market investment has become less attractive. Investors have been looking for other interesting asset classes and started to buy corporate bonds more actively. Corporate bond issuance has therefore risen strongly in the last few weeks. This led to a massive oversubscription of most newly issued corporate bonds. Corporate bond yields of AAA-rated companies average around 4.8% in the 10y and around 4.00% in the 5y segment. In the BBB segment investors can get yields of 7.8% (10y) and 6.4% (5y), which seem attractive in comparison to 10y German government bond yields (2.40%) and 5y Bunds (2.40%). However, Greek and Spanish government bond yields have risen strongly as well, and in the light of strong political support for these countries they might become even more attractive for relatively risk-averse investors. Nevertheless, the corporate bond market in particular currently seems to be a strong competitor for equities. Still, the equity markets managed to perform very well in recent weeks, mainly driven by the financial sector. The financial sector benefited from favourable news flow from the banking sector. In the next few months the already announced fiscal packages in most major countries should provide support for the economies as a whole and for the equity markets in particular. Basic materials could benefit most from this development. Thus, we expect the favourable equity market performance to continue in the next few months. The government bond market will probably underperform as the ongoing high issuance will keep a lid on this market. Nevertheless corporate bonds are unlikely to lose their attractiveness for investors.
Source: Trading Ideas ETF: Ideas and Flows – Deutsche Bank AG
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