Investors hate the basics these days. They hate what the earth provides. If it rusts, if it degrades, if it depletes, investors want no part of it.
I refer to commodities.
The S&P GSCI Commodity Index is near March 2009 lows, a time when everything was on sale. The GSCI is heavily weighted toward energy – crude oil accounts for over half the index’s weight.
But it’s not just oil, which has actually been rising in price. The Bloomberg Commodity Index is more equally weighted among energy, industrial metals, precious metals and grains than the S&P GSCI. The Bloomberg index is trading near a 12-year low.
There will always be a market for commodities. Commodities are the building blocks of everything, because everything originates from the earth. Commodities are iPhones, Chevys, Doritos, Big Macs and Nikes in their raw state. (To be precise, commodities are the potentiality of these products. Without human ingenuity to manipulate commodities, they are nothing.)
Supply and demand is the issue; it always is. Supply is high and demand is low, which has reset equilibrium at a lower price.
It’s no secret that producers, emboldened by low financing rates, have turned up the spigot on many commodities since the 2008-2009 recession. Oil and gas derived from U.S. shale is a perfect example.
Demand, though, has failed to keep pace. U.S. demand has warmed up, somewhat tepidly, since the world’s economies were iced over following the financial market collapse that occurred six years ago. Many Western economies, on the other hand, remain chilled – the European Union and Japan in particular.
So, to thaw their respective economies, the European Central Bank and Bank of Japan are injecting monetary heat. Both have embraced quantitative easing. The BOJ put markets on notice last October when it announced it would inject 80 trillion (yes, trillion) yen annually until the economy showed sustained nominal improvement. This month, the ECB began buying bonds to eventually inject a trillion new euros into the EU’s chilly economy.
Because other central banks are injecting more money, the U.S. dollar gains value vis-à-vis this new money. The Bloomberg Dollar Spot Index, which tracks the U.S. dollar against 10 currencies, has surged over the past six months. A stronger dollar tends to deter investment in raw materials, because international markets are frequently priced in dollars.
To state the obvious, commodities are ruled by uncertainty and fear. But one thing I’ve learned is that when uncertainty and fear reign, value and opportunity lurk in the shadows.
Most investors today hate commodities and the companies that extract them from the earth and deliver them to the market. To be sure, many of these companies have lowered revenue and earnings guidance. Many have also cut dividend payouts. Of course, lowered guidance and reduced dividends lead to lower share prices.
I see opportunity. Commodities are notoriously cyclical. Good times are invariably followed by bad times, and vice versa. The time to buy a cyclical stock is in the trough of the cycle.
The good news for value income investors is that commodity stocks offering 4% and 5% yields can still be found at these depressed levels and after dividend cuts. At both High Yield Wealth and Personal Wealth Advisor, I’ve doubled back and recommended investors add to the commodity-centric recommendations. At the same time, I’m finding many income commodity investments that offer the potential for substantial price appreciation.
The key is to look beyond the horizon to a supply-demand equilibrium unlike what prevails today. If you can do that, you might find the intersection of value and contrarian opinion priced into many commodity stocks enticing too.
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