Since 1982, market history strongly suggests that the underperformance of commodities should continue for a number of years.
The accompanying chart is simple but telling, providing investors with perspective on the average length of commodity cycles. The chart merely divides the Thomson Reuters continuous commodity index (which includes commodity futures pricing for 17 separate commodities) by the MSCI world index of global equities. A rising line indicates that commodity prices are outperforming equity markets while a falling line shows periods where investors were better off in equity markets.
The start date for the chart, June, 1982, is not arbitrary. In that month, the U.S. prime interest rate peaked at 21.5 per cent and headed lower as a signal that then Fed chairman Paul Volcker had successfully “broken the back” of inflation. Inflation devalues the U.S. dollar and, since resources are priced in greenbacks, U.S. inflation and commodity prices are inextricably linked – commodities fall as the dollar strengthens.
From June, 1982, to August, 1987, commodity prices significantly underperformed global equity markets. From that point until February, 1991, through a U.S. recession, equities and commodities performed roughly equally.
The remainder of the 1990s saw resources basically forgotten.
A strengthening U.S. economy, a strong U.S. dollar and the technology bubble saw equity markets outperforming commodity prices by a wide margin.
The bursting of the tech bubble in 2000 started an 11-year period where commodities outperformed equities. Between March of 2000 and August, 2011, the continuous commodity index provided a cumulative return of 214 per cent compared with a meagre 14 per cent increase in the MSCI world index.
This pattern of commodity outperformance then reversed. Since August, 2011, the commodity index has dropped 43 per cent and global equities have climbed 37 per cent.
The big question for Canadian investors now is, after almost five years of commodity underperformance, how much longer will they have to wait to buy more resource stocks?
There are two factors working against a resource recovery in the short term.
As the chart shows, we’re coming out of an 11-year upswing and it’s clear that excesses, in terms of corporate debt (commodity trading firm Glencore PLC is a notable example) and production capacity, are still apparent in extraction industries.
It will take time for these excesses to be addressed through production cuts and financial deleveraging.
In addition, expectations for global economic growth, and by extension commodity demand, are declining. Estimated global gross domestic product growth for 2016 has fallen from 3.8 per cent a year ago, to 3.3 per cent now.
Concerns regarding the Chinese economy – the nation remains the largest importer of virtually every commodity – remain a significant hurdle for resource prices.
Using the typical duration of a commodity cycle for investment purposes is admittedly a blunt tool. There are likely to be specific investment opportunities in the sector in the coming months. But for those investors on the fence about resource investments, history suggests waiting for more visible evidence of a recovery before jumping in.
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