Commodity prices have had a great ride over the past few years, but many experts believe that boom to be at an end. The implications are huge for Canadian investors because commodities drive almost half of the country's domestic equity market.
"You go back five years and we were sitting there looking at peak oil," says Craig Basinger, the Toronto-based chief investment officer at Macquarie Private Wealth Inc. "Copper was in short supply because of China's growth. The list was long as to why the bull market in commodities would last – it was the super-cycle that would just keep going."
No longer: Macquarie's latest outlook declares the super-cycle to be over and says investors shouldn't "expect to see the surprising commodity price increases of the last decade." Still, prices will stabilize, the report says, with some increases "in the order of 30 per cent or more still possible."
Demand for some commodities has been dampened by the global financial crisis, but supply has also caught up, Mr. Basinger says. Eighty-seven coal mines and 137 metal mines are under construction around the world, he says – as prices skyrocketed, companies began to invest in new mines and energy sources, all of which require long lead times, and "we're at the point where a lot of that is coming online."
Any discussion of commodities needs to recognize two crucial facts, says Patricia Mohr, an economist and commodities specialist at Bank of Nova Scotia. The first is their critical importance to Canada – commodities and resource-based manufactured goods make up roughly 45 per cent of the country's exports of goods.
The second is the growing importance of oil in our economy. When Scotiabank considered changing the weightings in its Commodity Price Index, "We discovered that crude oil and refined petroleum products are 28.5 per cent alone of Canadian net exports of all commodities." Forest products, in comparison, make up 14.7 per cent.
That impact could be felt last year. While many commodities did well in 2012, Canadian oil prices were down 25 per cent in December of 2012, compared with a year earlier, she says. Prices of oil-sands crude declined 33 per cent over the same period. A lot of oil, she adds, was being discounted, at up to $50 a barrel.
"You can imagine how much money this is costing us. It's humongous," Ms. Mohr says. And the situation will only be improved by better infrastructure – pipelines – and new markets, she says.
Materials and energy were two of the worst-performing sectors on the TSX last year, which finished with a 7.2-per-cent gain, Mr. Basinger says. In comparison, the S&P 500 climbed 16 per cent.
With a stock market so skewed to resources, muted commodity prices mean the TSX over the next year will be "pretty earnings-challenged," says Paul Taylor, chief investment officer for Bank of Montreal Global Asset Management.
Mr. Taylor predicts commodity prices will stay stable for 2013, and that investors in cyclical sectors such as energy and base precious metals will "be probably treading water" with flatter earnings. In the TSX over all, "We'll be lucky to see mid-single digits year-over-year earnings growth for 2013 versus 2012." Add in dividend yields of about 2.7 per cent, he says, and Canadian equities this year will have returns in the 6- to 9-per-cent range, "a far cry better than bonds."
Mr. Basinger says Macquarie believes that commodity prices are being kept higher than they normally would be "by the amount of monetary easing that's going on in the world right now" – a risky proposition for the future. It means that Macquarie is staying underweight in global cyclicals, which include energy and materials.
He also argues that if investors look at bull markets, there are typically different leaders each time. Commodities just had their turn, leading the last bull market in 2007 and 2008. Macquarie continues to invest in commodities, including energy, he says, but has become more defensive – choosing companies that are more focused on energy infrastructure such as pipelines or have diverse business lines.
Macquarie is favouring increasing its U.S. exposure, Mr. Basinger says, especially in so-called North American cyclicals such as industrials and technology.
On the industrial side, he says, that means investing in companies that are benefiting from lower energy and electricity costs, as well as the limited wage pressures that result from higher unemployment. As for technology, Macquarie is concentrating on firms involved with the Internet, software and communications equipment, rather than companies that rely on consumer spending on technology.
Forecast for selected commodities:
(West Texas Intermediate– U.S. $ per barrel)
(Avg. Alberta Plant-gate price– Cdn $ per mcf)
Gold: U.S. $ per ounce; All other metals are U.S. $ per pound.
Source: Bank of Nova Scotia