Insights for Investors by Investors

Why commodities are winning 2021

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The beginning of 2021 couldn’t have gone more smoothly for investment markets, delivering strong returns despite the events in Washington, DC. The first week of trading saw a continuation of the end of 2020, with Australian commodity companies, BHP Group (ASX:BHP) and OilSearch (ASX: OSH) pushing the market higher, adding 15% and 10% in the week alone, respectively. So, what’s driving the sustained performance?

One of the most powerful changes has been the continued weakening of the US dollar, spurred by the country’s huge monetary policy and growing issues dealing with the pandemic. With all major commodities priced in US$, like crude oil and gold, as the US$ devalues, these become cheaper for countries like Australia and China, resulting in an increasing in demand.

The confirmation of the election of Joe Biden as US President has also put a rocket under the oil price, despite earlier concerns of the opposite. With the electoral dust having settled in the US, the reality of a 50-50 Senate (with Vice-President Harris holding a casting vote) and slimmer Democratic margin in the House of Representatives leaves the Democratic party and the President-Elect triumphant, but still limited in terms of their legislative ambitions. Still, the Democrats have two years in which to move; but the ‘light blue wave’ means they may not be able to pass the entirety of their program in a single term. Markets are now predicting that the short-term focus will be on providing additional fiscal stimulus to the US economy, including in the form of infrastructure spending, which markets hope, when combined with the rollout of the vaccine, will reflate the economy.

Similarly, it has been the Chinese Government’s obsession with infrastructure and construction stimulus that has supported ever-higher iron ore prices, in a boon for the Australian economic recovery.

Yet the most powerful change for the oil came this week, from OPEC+, but more specifically, Saudi Arabia.The price of Brent Crude moved past a ten-month high of USD$55 a barrel, after the Kingdom announced it would cut production by as much as one million barrels per day (and they said we were already at ‘peak oil’). It is clear that the Saudis continue to favour higher prices, and therefore higher profits, over higher volumes of production.

The production cut will offset the planned increase of 75,000 barrels per day by both Russia and Kazakhstan, with the former seeking to pre-empt any rebound in US shale production by sending prices lower. It is possible to read two stories out of this production cut. On the one hand, the Saudis seem increasingly concerned about European and UK demand in light of the worsening outbreak and economic shutdowns. On the other, it suggests that traders are expecting the economic recovery to quickly gather steam. 

Either way, the sector remains one where the risk-reward profile is evenly balanced, rather than in the favour of investors, and is complicated by Australia’s unclear energy policy.

There are a number of ways to access the energy sector, ranging from direct ASX-listed companies like BHP (which still generates around 25% of revenue from oil), Santos (ASX:STO) and Woodside (ASX:WPL). Alternatively, the Ausbil Global Resources Fund offers a more diverse exposure, as does Betashares Global Energy Companies ETF (ASX:FUEL).

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