In the last few years the prices of a range of commodities have come under severe pressure. This has left many investors in lossmaking positions and has severely impacted the FTSE 100 index. That’s because resources companies make up around 17% of the index even after their share price falls. As such, the fate of gold, oil and iron ore is crucial to the future performance of the stock market.
Going for gold
For investors in gold, 2016 has got off to a great start. There were concerns at the end of 2015 for the precious metal’s fate since it seemed likely that multiple US interest rate rises would occur during the course of this year.
However, with the turmoil in global markets and the high degree of uncertainty now present, the prospect for monetary policy tightening this year has faded. This has caused gold’s price to rise by 13.5% since the turn of the year, largely due to it having historically moved inversely to the direction of interest rate changes in the past. In other words, the reduced chance of an interest rate rise has been positive for gold.
Furthermore, gold has somewhat returned to its status as a store of wealth and safe haven among investors. This has aided its performance in recent weeks and with the prospect of further volatility being likely during the rest of the year, gold could continue to outperform a number of other commodities moving forward.
Moving in the opposite direction to gold have been oil and iron ore. They’ve both hit multi-year lows in recent months, with a supply glut and reduced demand hurting their respective outlooks. And with the prospect of major changes in both of these areas seemingly unlikely in the short run, it looks set to be a long road back to recovery for both commodities.
Down but not out?
Of course, in the long term both oil and iron ore have the potential to rise significantly from their current levels. Demand for energy is forecast to rise by as much as 30% in the next 20 years and although renewables will make up a larger part of the energy mix, fossil fuels such as oil will still play an important role – especially in developing nations. And with the industrialisation of the emerging world continuing apace, demand for the steelmaking ingredient iron ore is likely to pick up over the coming years.
Clearly, current price levels in oil and iron ore are uneconomic for a number of producers. Therefore, supply could also be reduced in the coming years – especially in the oil industry where exploration spend has been slashed in the last year. Therefore, it seems logical to focus on buying producers with relatively low cost curves and that have strong balance sheets so they can afford to survive in a low-price environment.
As ever, buying the commodities themselves could prove to be a risky business and it means zero income for the investor. Therefore, it seems prudent to stick to financially sound and resilient companies within the resources sector. For long-term investors who can stomach short-term volatility, doing so could prove to be a very profitable move.
