Have Commodities Bottomed Out?
(Continued from Prior Part)
To be sure, the supply and demand situation can change quickly, particularly for oil, and lower prices are having an impact on demand. Still, most of the factors that have put commodity prices under pressure are likely to remain in place through the remainder of this year.
Given this, I’m not expecting an imminent, or strong, rebound in prices this year. Oil, for instance, should level off around current levels, but it’s hard to imagine a strong rebound in the absence of a sharp reduction in non-U.S. production.
What are the implications for investors? All of this leaves the commodity producers as a more interesting opportunity than the physical commodities. For investors with a longer-term view, say three to five years, some bargains are beginning to emerge.
However, investors need to exercise selectivity. While most commodity-related stock sectors are cheap, the plunge in valuations tends to track diminished fundamentals, i.e. falling earnings and profitability. This suggests that commodity prices may need to move even lower or, alternatively, fundamentals need to start improving, before commodity companies become a genuine bargain.
That said, I do see some relatively attractive valuations among U.S. drillers, U.S. refiners and U.S. metals and mining firms.
Market Realist – The energy sector is suffering from the decline in crude oil prices (USO). Restructuring and layoffs in the sector are becoming a norm of sorts. According to the Labor Department, September saw a decline of 10,300 jobs in the mining industry. Oilfield services (OIH) (IEZ) and other support activities saw a decline of 7,200 jobs in September while 1,100 jobs were lost in the oil and gas extraction sector (IEO). According to the Labor Department, the mining sector has seen a decline of more than 102,000 jobs in the past nine months alone.
Chesapeake Energy (CHK) has announced plans to cut its workforce by almost 15%. Caterpillar (CAT) has announced plans to lay off more than 10,000 workers. Halliburton (HAL) has also announced cuts to its workforce while the aluminum giant Alcoa (AA) has announced a split that will divide the company into two distinct businesses next year.
In the context of the current environment, we believe that commodity prices are still some ways off from a bottom. The outlook for energy investors does not look bright for the rest of the year, as most headwinds that have affected the sector so far continue to persist.
The demand-supply mismatch is likely to remain a problem going into the next year, and thus a sharp and sustained rebound in prices may not be in the cards. Long-term investors can find some bargains in the energy sector, but selectivity is key. Investors should be privy to the fact that most of the attractive valuations in the energy sector have come at the cost of declining fundamentals, and investors should thus exercise caution.
Opportunities can be found in the refining sector, which tends to benefit from low oil prices. Crack spreads measure the price difference between the sale of finished refined products and the price of crude oil. Thus, crack spreads, or refiner margins, tend to widen with a decline in oil prices. The above graph shows the crack spreads for the US Gulf Coast over the last week. Investors should keep track of the crack spreads while investing in the refining sector. Investors can make a play on crack spreads by investing in the recently launched Market Vectors Oil Refiners ETF (CRAK). However, since the ETF tends to focus on global refiners and not just refiners in the US, investors should account for currency fluctuations while investing in the product.
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