Base metals
Prices of base metals and iron ore have fared much worse than oil, given their greater dependence on Chinese investment spending. Copper and iron ore prices in particular have performed poorly as they have heavy exposure to the Chinese construction and steel industries.
The larger blue-chip companies typically have the lowest-cost mining deposits and can maintain production, while the smaller, more marginal firms are forced to shut down their projects.
Precious metals prices have held up better than those of base metals over the past year. This is perhaps not so surprising in light of the increasingly easy monetary policies being pursued around the world.
Although the US and the UK are no longer increasing the size of their quantitative easing programmes, their effects have been replaced by the European Central Bank and by the increased efforts of the Bank of Japan.
Bear markets
As is typical in commodity bear markets, the smaller companies, in both the energy and mining sectors, which are less diversified and typically have greater operating and financial gearing, have performed much worse than their larger brethren.
This can create difficulties for natural resources funds since their benchmarks are skewed to the largest stocks. It is very difficult to be overweight these stocks and they tend to show the strongest relative performance in poor market conditions.
Thus those funds that invest just in natural resources producers and avoid the more industrial companies will have above benchmark exposure to the small and mid-cap stocks in the sector, and this will lead to greater underperformance in poor market conditions and greater outperformance in good market conditions.
Across the entire natural resources sector, companies’ attention is now fixated on reducing expenditure and building cashflow. This will mean dramatic cutbacks in new exploration efforts that should, in time, create future shortages and higher commodity prices, leading to the next cycle. As always, the key to investment performance will be in its timing.
Over three years to the end of September 2015, the Morningstar category Equity Natural Resources average fund performance was -44.7%, and over 12 months to the same date it was -36.9%, compared with the MSCI World Natural Resources benchmark performances of -23.3% and -29.9%, respectively.
Fund flows in the past year reflect the positive sentiment expressed above. During January and February 2015, despite the very negative performance, broad-based commodity funds received net inflows of almost €2bn.
