Friday, August 19, 2022

Goehring & Rozencwajg - Q2 Natural Resource Market Commentary

[Previously from Goehring & Rozencwajg: "The Distortions of Cheap Energy" and Goehring & Rozencwajg and Horizon Kinetics on Commodities.]

Highlights from Goehring & Rozencwajg's second quarter 2022 Natural Resource Market Commentary, "Why Resources During a Recession":

  • Both energy and materials are considered extremely economically sensitive. Oil has pulled back almost 30% from its June high of $120 per barrel, and Dr. Copper, the metal with a PhD in economics, suggests a global recession is looming. Natural resource investors went from asking, “Have I missed it?” to “How can we possibly allocate money to resources if we are heading into a recession?” in a matter of weeks. These worries are not unfounded. During the Global Financial Crisis (GFC), natural resource stocks collapsed. Materials and Energy were two of the worst four sectors in the S&P 500 (along with Real Estate and Financials), falling 60% from May 2008 to March 2009. As recession fears took hold a few months ago, traders fell back on the same tactic. As the market sold off from June 8th to July 12th, materials and energy were once again amongst the hardest hit sectors, falling 15-25% in only a month. We strongly discourage investors from using recessionary fears as a reason to sell commodities. Commodity markets today bear no resemblance to 2008. Investors using the 2008 GFC playbook risk selling commodities right at the bottom, missing the huge potential returns embedded in these markets over the coming decade. When investing in natural resource equities, the commodity capital cycle is far more important than the broad economic cycle.
  • The key insight here is that the commodity capital cycle may or may not correspond with the broader business cycle (i.e., expansion and recession). Heading into the GFC, the two cycles were in near-perfect alignment. Commodity prices were extremely high relative to the stock market in early 2008. Energy and materials made up 20% of the S&P 500 – a 30-year high. Natural resource capital spending had accelerated. Driven by high prices, insatiable Chinese demand, and endless analyst calls for a commodity “super-cycle,” energy and mining capital spending in the S&P 500 surged four-fold between 2000 and 2008 from $80 bn to an all-time high of $330 bn per year. When the recession arrived, the commodity sector was hit hard. Energy stocks fell by 50% while mining stocks fell 65%, gold stocks fell 25%, and agriculture related equities fell 40%. Natural resource equities rebounded in 2009 and into 2010, but then entered a decade-long bear market. The capital spending surge during the bull market of the middle-2000s ultimately resulted in new production of almost everything: iron ore, coal, copper, shale gas, and oil. The GFC represented a rare alignment of a bearish commodity capital spending cycle and a bearish broader business cycle. It is no wonder that investors are skeptical of natural resource investments given the experiences of the GFC. However, we think focusing solely on one episode risks missing the point. As it relates to natural resources, the GFC was an anomaly: for most of the past 120 years, the commodity cycle and the business cycle have not been in sync at all. In fact, throughout the twentieth century, resource equities have actually been good investments during most recessions.
  • In this context, the GFC was indeed a unique episode in which the commodity capital cycle and the business cycle were in sync. After several years of strong performance capital had rushed in and new projects abound. As a result, prices fell sharply during the GFC, recovered somewhat, and then entered a 10-year structural bear market. Today conditions couldn’t be more different than those preceding the GFC. Commodities and natural resource equities have never been cheaper and more out of favor relative to financial assets. In 2020, energy and materials made up less than 2% of the S&P 500 compared with 20% in 2008. Because of the 2010-2020 commodity bear market, capital spending for almost all extractive industries has been severely curtailed. For example, in the energy industries, capital spending in the S&P 500 has fallen from $320 bn per year to less than $100 bn today and, as you will read in the “Incredible Shrinking Super Majors,” what capital remains is not being spent efficiently.

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