Is the super cycle over?

Time to move on from commodities to global stock picking

Morgan Stanley last week joined a growing list of big investment banks beating a partial retreat from commodities trading. Like Barclays, UBS and Deutsche Bank, it is struggling to make sense of a business where revenues have tumbled since the hey-day of the natural resources boom immediately prior to the financial crisis. So is the commodities super-cycle over?

For three reasons, I think the remarkable rally in the prices of energy and metals (although maybe not food which marches to a different beat) may have ground to a halt. If so, this might have big implications for investors.

The first headwind for commodities prices going forward is the likely strength of the US dollar, the currency in which most resources are priced. As the US currency rises in value, commodity producers are prepared to accept a lower price because their income remains unchanged in their own currency. And why should the dollar appreciate from here? A combination of economic recovery, interest rates returning to pre-crisis norms, a better trade balance and structural improvements in America’s fiscal situation. Put these together and I expect a decade-long dollar decline to reverse.

The second key driver of commodity prices is demand and here too the outlook points to further declines. The principal reason for this is the ongoing rebalancing of the Chinese economy away from manufacturing, infrastructure investment and exports to domestic consumption. This coupled with a slowing in the overall rate of GDP growth in China means the country, while clearly still a big consumer of resources, will have less of an impact on prices at the margin. Five years ago, exports and private consumption both accounted for about 35% of Chinese GDP but in five years’ time those proportions will probably have become 25% and 40% respectively, a huge relative shift in only ten years.

Thirdly, even as demand for commodities is likely to moderate, the supply of energy and metals is expected to increase in the years ahead. This is a natural consequence of a decade of rising prices which has made previously unviable extraction of, for example, oil from Canadian tar sands financially worthwhile. It is also a result of technological advances, the main driver of the Shale gas revolution in the US about which I’ve written here a few times.

So a combination of dollar strength, weakening demand and increased supply looks like a recipe for lower commodity prices from here. What does this mean for investors?

Firstly, I think it will be broadly supportive of global growth. Lower energy costs increase disposable incomes for individual consumers and cheaper energy and metals reduce input costs for industry.

Secondly, weakening commodity prices contribute to the relative attractiveness of developed markets such as the US, Japan and Europe compared with emerging markets. The West is principally a consumer of commodities and the developing world a producer, although clearly this is a generalisation which will be less true in time as and when the US overtakes Saudi Arabia to become the world’s leading oil producer.

Thirdly, lower commodity prices are likely to lead to lower inflation, which in turn provides central banks with the cover to keep monetary policy looser for longer. In this context, I think the nervousness over the Fed’s tapering of quantitative easing may well have been overdone. The big problem in many economies is debt, public and private, and that makes them extremely sensitive to rising interest rates. Policy will remain easy for longer than some people now believe.

Finally, easing commodity prices could lead to a reduction in the risk-on, risk-off, macro-driven market movements which have characterised investment for the past few years. For one thing, the free lunch in emerging markets looks to be over. The rising tide has lifted all boats in the developing world and investors are going to have to be much more discriminating with their emerging market investments. My colleague Anthony Bolton’s long-held belief that investors will start to differentiate between those companies in China exposed to rising consumption, and those still dependent on an increasingly redundant export and investment model could come good just as he hangs up his boots next year.

Winners and losers from the end of the commodity super-cycle will be found at the country level and among individual stocks and sectors. Domestic Chinese airline, US steel-maker or Australian iron-ore producer? Working out where in the supply chain the real pricing power resides will be key. Trading commodities may not be very rewarding right now but it’s never looked a better time to be a bottom-up global stock picker.

By Tom Stevenson, Investment Director, Fidelity Worldwide Investment

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This follows a change in portfolio and research responsibilities, and is an outcome of UBS Global Asset Management’s (UBS Global AM’s) acquisition of ING Investment Management (INGIM). 

David Scott and Patrick Barrett, previously members of the INGIM Australian property securities team, are assuming the management of the UBS Property Securities Fund and, more broadly, A-REIT research for UBS Global AM and UBS Global Real Estate Securities. 

Within UBS Global AM, Vinay Narsi, who was covering property securities, will take on broader industrials coverage. Jacov Males will relinquish portfolio management of the UBS Property Securities Fund, and assumes management of the UBS Australian Share Fund from head of Australian equities Simon Shields. Mr Shields has assumed portfolio-management responsibilities for a number of INGIM-managed Australian equities products. 

S&P will meet Mr Scott and Mr Barrett shortly, as well as the UBS Global Real Estate Securities team, to ascertain how the current strategies will be affected and to resolve the ratings of both funds. 

These appointments are among several changes announced yesterday, following the settlement of UBS Global AM’s acquisition of INGIM. These changes affect both UBS Global AM- and INGIM-managed Australian equities and Australian fixed income strategies. There is no change to S&P’s ratings of these products at this time, with INGIM-managed products remaining ‘On Hold’. We will continue to monitor developments as the integration of the business continues into 2012.

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