ANALYSIS: Is commodities a key call for 2017

Added 13th October 2016

2016 has been a good year for commodities. Year-to-date, the FTSE World Mining index is up just less than 56% in dollar terms, while the FTSE oil and gas index is up just less than 20%.

ANALYSIS: Is commodities a key call for 2017

Such a return to form has been welcome after a pretty dismal performance for the preceding few years, but it has also left the market wondering how much juice is left in the rally.

 

The problem is, the commodities complex is just that - complex. And, there are cogent arguments to be made on both sides of the coin.

According to Evy Hambro, mining companies have experienced significant cost deflation in the past couple of years. Not only have they stripped out a lot of cost from their businesses both in terms of labour and unproductive assets, but they have also benefitted from lower input prices.

At the same time, he says, there has been an uptick in prices that has been good enough to enhance margins and increase profitability, but that has not been big enough to encourage new investment decisions.

“We have become very confident on the outlook for the companies,” he said. “The cost out has been extraordinary in terms of the scale, the cost curves have dropped a lot across the industry. You can say that that number is thus artificially low and will go up as they start spending on capex, but if they don’t have anything to spend it on, because they don’t have good enough projects to build it is just going to remain low.”

That is the debate going on at the moment, Hambro said, in terms of how much one should pay for these companies.

“I think the market as a whole has missed how much the debt in these companies has been reduced and how much free cash flow they are now generating. If you look at things like the Bank of America Fund Manager Survey, everyone is underweight materials and overweight areas with margin issues or expensive bond proxies,” he said.

Adding: “The broader market is underweight the sector, it has very high cash flow yields, the companies have dealt with their debt, they are not spending much on capex, and their pay-out ratios are very low - many cases they have cancelled their dividends. Looking into 2017, what is a reasonable forecast for the mining sector? It is rising dividends, strong cash flow yields, company management teams remaining disciplined around capital allocation, a continued deleveraging of the businesses.”

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About Author

Geoff Candy

Group digital editor

Geoff Candy joined Portfolio Adviser as News Editor in May 2014. He has been a financial journalist and broadcaster since 2005 and, in that time has worked in both South Africa and the Netherlands, covering everything from high street retailers and construction companies to mining and insurance.

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