SSGA-SPDR: All the excitement of a commodities supercycle

February 25, 2021

We have seen significant investor attention on reflation as one consequence of the economic reopening story. Among the headlines is the commodity supercycle and its implications for equities. Figure 1 shows how far a wide range of commodity prices have risen month to date.

The largest price moves have come from natural gas and crude oil. And while these moves are impressive, some of the drivers of this phenomenon (primarily the disruption to production caused by the deep freeze in Texas and surrounding US states) are likely transitory.

Meanwhile, the driving forces behind the rise in industrial metals may have more longevity. Interestingly, acceleration of US producer prices in January and a strong ISM manufacturing prices index have indicated that suppliers have pricing power for a range of intermediate materials prices like metals, chemicals and plastics.

In light of the above dynamics, one sector in particular should benefit: Materials.

What’s driving metals prices?

The fundamental reasons for this surge lie in the strength of demand, driven primarily by China. Moreover, moves have become increasingly synchronous on a global level as heavy industries start to recover, and restrained supply due to production and supply chain disruptions courtesy of the COVID pandemic has also bolstered the price.

Copper is particularly interesting. It is one of the most used industrial metals, with China accounting for nearly half of global copper demand. Prices of the metal have risen more than 80% from lows last year. Estimates suggest the price could rise further, based on:

• Use in construction and house building, electronics and automobiles – these factors make the metal a key economy reopening play for investors.
• Importance to electric vehicle production – a typical electric vehicle contains 83 kilos of copper (for high voltage wiring, rotors, etc.), which is four times that of an internal combustion car.
• Momentum of green transition – copper electrical wire is widely used in renewable energy sources.
• Stockpiles are at a decade low – copper mine production has been impacted by shutdowns last year.
• While eventually price hikes are likely to drive a supply response, the usual multi-year lag-time for project commissioning means that significant increases in production will not happen for several years.

Materials plays into many of today’s market themes

Let’s look at MSCI World Materials, which has already shown strong outperformance compared with global equities, having bounced hard during the market recovery since late March 2020, and then in the cyclically orientated markets since the vaccine announcements of early November 2020.

mong the industries in Materials, metals and mining (35% by market cap of MSCI World Materials) has seen the highest returns, with total returns of 118% since the March 2020 lows. Following in that industry’s wake, but still showing overall outperformance of the broad index, are the chemicals (51%), containers and packaging 6%) and construction materials (5%) industries.

This strength could continue, as recent results show that not only are mining companies proving adept at passing on metal price rises, but current conditions have enabled them to make positive dividend announcements.

Other important themes driving the Materials sector:

• Traditional reflationary play – the sector has a relatively high sensitivity to inflation and is well placed to pass on commodity price rises.
• Sensitivity to economic growth – the sector also has a relatively high sensitivity to PMIs (both scores can be seen in the SPDR Sector Compass). Manufacturing PMIs are now above 50 in most large countries.
• Chinese demand – the country is a net importer of many raw materials.
• Chemicals benefiting from both demand and supply side dynamics – as orders bounce back during industrial production recovery and margins see the benefit of supply side constraints and low input costs.
• Prospects of fiscal stimulus – still hoping for future US public spending to encompass infrastructure plans.
• Earnings sentiment – the sector is seeing supportive forecast upgrades after a high level of positive earnings surprises during Q4 results and higher commodity prices
• Forecasts for a weaker US dollar – this could also boost metal prices.
  The positive price momentum currently in the Materials sector can be clearly seen when looking at our new Sector Momentum Map. Focusing on Europe Materials: go to “Europe sectors ETF”, set the time period to “1 day” and select ”STP FP from the securities list” to see how the sector has recently moved from the Improving to Leading quadrant.