Monday Markets — Commodities

Monday, 15 February 2021
Wollongong, Australia
By Greg Canavan

[4 min read]

I spent the weekend moving house.

Six months ago, my family were locked down in Melbourne with zero confidence in the ability of the Andrews government to manage the situation. Cut off from loved ones, we had zero confidence it would be able to handle subsequent outbreaks either.

So we made the decision to move to Wollongong. We spent two weeks in hotel quarantine. Then four months living with my parents…in the house I grew up in. That was weird. Three generations under the one roof.

But we soon found a lovely home and made the move on Friday. I did note the irony that on the day we moved in, Victoria found itself locked down again. Was it bad luck or bad management?

I instinctively guessed the latter, but Robert Gottliebsen confirms it, writing in The Australian this morning…

The latest Victorian COVID-19 lockdown was caused by two catastrophic errors. First, a complete breakdown in the communication, decision-making and administrative systems of the Victorian bureaucracy and ministry. And second, the failure of WorkSafe and the crown prosecutors to investigate properly and prosecute the blatant abuse of Victoria’s occupational health and safety rules that led to 801 deaths last year.

Had WorkSafe done its job it would have ensured that proper systems were put in place.

The current mismanagement is so bad that it puts the health, safety and lives of Victorians and Australians at risk. Victoria may have to stop hotel quarantine even though it has a crisis plan gathering dust in a drawer that is the basis of how other states successfully manage quarantine.

Thankfully, Australia’s crucial commodity export sector isn’t at all impacted by the ineptitude of Victoria’s swollen bureaucracy. Unlike thousands of small businesses, our commodity producers continue to do well from all the stimulus spending thrown at the global economy.

So I thought this week we’d have a look at the sector and see how it’s travelling.

Let’s look at the overall sector first, via the broad CRB Commodities Index. It consists of 19 commodities with various weightings.

The agricultural sector is the largest, and makes up 41% of the index. The main constituents are corn, soya beans and live cattle (6% weighting each).

Energy comes in second at 39%. WTI crude is the bulk of that, at 23%, followed by natural gas (6%) and heating oil and unleaded gas (5% each).

Precious metals make up 7% (6% gold and 1% silver).

Industrial metals account for 13% of the index, with copper and aluminium 6% each and nickel 1%.

With that in mind, check out the performance of this broad grouping of commodities…


Source: Optuma

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As you can see, the sector is back where it was at the start of 2020, pre the COVID panic.

Since bottoming on 2 November, the index is up nearly 30%! Strength has been broad based.

The sector is extended from a short-term perspective though. The index is well above its 50-day moving average (blue line). So don’t be surprised to see a bit of a correction or sideways consolidation play out over the next few weeks.

Agricultural commodities like corn and soya beans have been especially strong, and now trade at their highest price since 2013 and 2014 respectively.

The next biggest weighting, is energy, and WTI crude specifically.

Since the November low, WTI crude has rallied nearly 70%! It’s extended in the short term too. But there are reasons to think that longer term; prices might head back toward the US$80 a barrel region.


Source: Optuma

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The simple fact is there are longer-term supply issues building. 

While everyone is focused on the long-term demand destruction brought about by the ‘green revolution’, that will be accompanied by supply destruction too.

It is now very time consuming and expensive to get major energy projects approved, especially in the West. There are major environmental and social hurdles to overcome. And then there is the view that renewables will be powering the economy in the not too distant future.

In my view this optimism is misplaced. Fossil fuels will be essential energy for years to come. I believe demand will surprise to the upside while supply will surprise on the downside. The result will be much higher prices than nearly anyone expects.

That’s a longer-term story. The short-term driver behind the recent price rise, at least as far as I can tell, is the expectation that US domestic oil production will fall this year. It hit a record 12.86MMBoe/day in November 2019.

The latest reading from the Energy Information Administration showed November 2020 production at 11.2MMBoe/day. That’s not much of a drop given the hole the US economy fell into.

But you can’t just turn a lot of production off like a tap, especially the shale/tight oil production that has become so dominant in the past few years.

According to US Oil Analyst Art Berman, it takes four–five months from initial drilling to get to first production. From there it takes another six–eight months for the shale/tight oil wells to move into the decline phase.   

Put it all together, and Art reckons you’ll be seeing significant US production declines starting to come through soon.

Whether OPEC/Saudi Arabia will move to plug the gap is an open question. But after a very tough 2020, you’d expect them to sit back and enjoy higher prices for a while.

Copper has been even stronger. It’s up around 80% from the March lows and looks very strong. Copper is considered a ‘green’ commodity, given its extensive use in the renewable economy. This will no doubt underpin long-term demand.

But an 80% price rise will also no doubt bring about a supply response. So with copper back at prices last seen in 2012, and getting close to its 2011 highs again, it’s probably worth exercising caution here.


Source: Optuma

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The conclusion to all this is that, broadly, commodity prices look strong here, albeit they are ripe for a short-term correction.

In my view, the best way to play this is via the energy sector. Many ASX-listed oil and gas plays are still well below their former highs. The market is yet to warm to the idea that energy prices could rise further for longer.

You can see this in the chart of the ASX 200 Energy Index, below. If you’re investment horizon is two–three years, the recent pullback gives you a nice entry point…


Source: Optuma

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I’ll leave it there for today.

Continue below for your ‘Week Ahead’ update from Murray Dawes. Today, Murray looks at a stock that just announced its biggest half-year revenue in the company’s history. After suffering through COVID and seeing a huge crash in its share price, it looks like the corner has been turned.

Catch you again on Wednesday…

Cheers,
Greg


[WATCH] Bouncing Back from COVID

By Murray Dawes

Today’s stock copped a beating in the COVID crash.

But since then, the price has been grinding higher in a steady trend and the half-year results, which were released today, have been well received by the market.

They announced the highest half-year revenue in the company’s history; although the figures just pipped the revenue they were doing prior to the crash.

They produce market-leading products that help digital content creators produce high-quality video content at lower production costs than have been possible in the past.

They have a wide range of products that appeal to many different levels of expertise in video production. From vloggers uploading videos to YouTube to professional production studios.

They have a market cap of $200 million and their first half revenue came in at $32.8 million. That gives them revenue to sales multiple of around three–four times, which isn’t stretched.

They achieved an EBITDA of $3 million in the half and generated $4.3 million cash giving them $23.3 million cash on the balance sheet.

The technical situation is quite compelling with the monthly buy pivot now in place and the buying pressure in the stock consistent.

I show you multiple ways that short- and long-term traders could approach a trade in the stock in the video above.

Regards,

Murray Dawes Signature

Murray Dawes,
Editor, Pivot Trader