Pay close attention to where commodities are relative to equities right now. Compared to the S&P 500 Index, materials are extremely undervalued, the most since at least 1970. This makes now a very attractive entry point—or as natural resource investors Goehring & Rozencwajg Associates writes in its quarterly report, there could be “a proverbial fortune to be made” if investors take advantage of this once-in-a-generation opportunity.
“When commodities are this cheap relative to stocks, the returns accruing to commodity investors have been spectacular,” the firm continues:
For example, had an investor bought the Goldman Sachs Commodity Index (or something equivalent) in 1970, by 1974 he would have compounded his money at 50 percent per year. From 1970 to 1980, commodities compounded annually in price by 20 percent. If that same investor had bought commodities in 2000, he would have also compounded his money at 20 percent for the next 10 years.
Past performance doesn’t guarantee future results, of course, but the implications here are very compelling if mean reversion takes place. There have been few times that I can remember when an asset class looked as favorable as commodities do now. If you agree, it might be time to consider adding exposure to materials, energy and mining to your portfolio.
Oil Just Had Its Best January Since 2006—Further Gains Ahead?
Energy in particular looks very attractive. West Texas Intermediate (WTI) crude oil, the American benchmark, logged its best January since 2006, gaining more than 7 percent on scorching hot demand, sustained production cuts by the Organization of Petroleum Exporting Countries (OPEC), deteriorating output from Venezuela and a record-setting stockpile drawdown. U.S. oil inventories declined for 10 straight weeks as of January 24, the longest stretch ever recorded, before jumping again in the week ended January 31.
What’s more, the U.S. Energy Information Administration (EIA) just reported that, thanks to the revitalized shale revolution, the U.S. produced over 10 million barrels of oil per day in November, the first time it’s done so since 1970. This puts the country on a path to catch up with and possibly exceed Russia, which produced an average 11 million barrels a day in 2017, and world leader Saudi Arabia, whose energy behemoth Saudi Aramco produces around 12.5 million barrels a day.
As I’ve written many times before, the American fracking industry is largely responsible for keeping global oil prices low, which has been a huge windfall to the world economy. In its coverage of the news that U.S. output topped 10 million barrels, the Financial Times put it best, writing that American frackers have “boosted the U.S. economy, creating tens of thousands of jobs, bolstered its energy security, created new international relationships and given Washington new freedom to use sanctions as a tool for strategic influence.”
But shouldn’t all this extra supply halt the oil rally and put a damper on producer and explorer stocks? Not so fast.
Companies Just as Profitable with $65 Oil as They Were with $100 Oil
In the years since oil prices cratered—and subsequently began to rise—energy companies have become much more efficient and have learned to do more with less. As the Financial Times notes, U.S. frackers are producing what they are today while employing only three quarters of the workforce they had in the days of $100-a-barrel oil. ExxonMobil, the largest American producer, is in expansion mode, with plans to ramp up its shale mining in the Permian Basin to 500,000 barrels a day by 2025.
It’s not just American companies that have grown lean and mean in this climate of lower oil prices. Says the chief financial officer of Royal Dutch Shell: “We are able to do the same for less.”
Europe’s largest producer this week reported that profits tripled in 2017, generating nearly as much cash flow as when oil prices hovered around $100.
According to the Wall Street Journal, the company has “fundamentally revamped the way it designs and executes projects and is working to deliver another $9 billion to $10 billion of savings in the coming years” through restructuring and by paying down loads of debt.
As a result, Shell has rewarded its shareholders well, delivering a dividend yield of nearly 6 percent, among the highest in the entire industry.
These rewards could continue, as Goldman Sachs now sees Brent jumping to $82.50 within the next six months, up from just under $70 today. Hedge funds’ net long position on Brent hit an all-time high of more than 584,000 contracts last week, according to ICE Futures Europe and reported by Bloomberg. WTI net long positions also surged, according to the U.S. Commodity Futures Trading Commission, to nearly 500,000 contracts, the most since 2006.
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