How to navigate rising commodity prices in portfolios

Even after surging prices in recent weeks, there may be more gains in commodities for investors who choose the right companies and take a diversified approach, portfolio managers say.

As much of the world continues to cut off Russia economically and ban imports due to the invasion of Ukraine, commodity prices for resources such as oil, nickel and wheat continue to surge. Most notably, oil prices have reached their highest levels since 2008. On Wednesday afternoon, Brent crude was trading around US$110 per barrel.

Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners,  said investors should look at energy companies “with a fresh set of eyes.”

“Are stocks attractive today irrespective of how well they’ve done? Because if you haven’t been in the energy trade, if you don’t look at current valuations, it would be very easy to think that you’ve missed the run,” said Nuttall, who manages the Ninepoint Energy Fund.

The S&P/TSX Capped Energy Index had a return last year of 63.6%. So far this year, the index has a 36.7% return. But regardless of geopolitical issues, Nuttall said he believes oil is in a multi-year bull market that is going to end in all-time high oil prices.

He expects demand for oil will grow and that the era of U.S. shale production exceeding global demand is over. The Organization of the Petroleum Exporting Countries (OPEC) will exhaust its current capacity in the coming quarters, he said, and there’s a lack of investment to quickly increase production.

“People are recognizing what we’ve been talking about for well over a year — we’re in a structural bull market for oil. The events of Russia and Ukraine have fast-forwarded the inevitable outcome of that,” Nuttall said.

Even with an oil price $20 lower than today, Canadian oil companies will generate significant free cash flow, he said. Ninepoint is approaching the oil market by being “fully invested” and “seeking out companies whose free cash flow is increasing exponentially with the rise in oil prices,” which could lead to share buybacks and dividend increases.

The volatility in oil prices also means there’s a case for active management, Nuttall said. “Stocks are up and down 5% in a day.”

Daniel Greenspan, senior analyst and resource team director at CIBC Asset Management, noted the energy market was tight even before the Russia-Ukraine war. Suppliers haven’t kept up with demand that’s picking up as pandemic restrictions ease around the world.

On the precious metals side, the market is “lacking conviction” on the direction of the gold price, said Greenspan, who manages the CIBC Canadian Resources Fund, the CIBC Energy Fund and the CIBC Precious Metals Fund.

Gold has been hovering around US$2,000 this week, up more than 12% this year. But heading into a rising interest rate environment presents “a headwind for gold,” Greenspan said.

He also noted how Russia and Belarus make up about 40% of the world’s potash market.

“If those exports are constrained, then growers around the world will struggle to find the supply they need to properly fertilize their crops,” he said, adding prices could go up.

Shares of Canadian potash producers such as Nutrien Inc. have soared since the Russian invasion.

The other type of fertilizer this impacts is nitrogen, Greenspan said, as Russia exports a significant amount of natural gas to Europe. According to the International Energy Agency, last year 45% of European Union gas imports came from Russia.

If nitrogen production is curtailed, or natural gas prices go higher, there’s potential for the price of nitrogen to increase, he noted.

“All of that feeds into crop prices, which could potentially move higher, with higher input costs in the fertilizers, and then you start to see food inflation.”

Advisors should take “a basket approach” to commodities, Greenspan said, as it’s best to be diversified.

“We’re not just trying to pick one or two winners in energy or copper, but three to five different names. Give yourself a wide range of exposure to the sector and reduce some of the company-specific risks,” he said.

For Ken O’Kennedy, chief investment officer at Dixon Mitchell Investment Counsel in Vancouver, there could be more upside in oil and gas exploration and production companies. However, “the risk-reward is not great.”

“I don’t think there’s a simple solution on the [oil] production side/supply side, because demand keeps growing,” he said.

Within the context of Russia-Ukraine, O’Kennedy said clients are concerned about how the geopolitical tension is affecting their spending power.

“Clients are very concerned about how this is impacting their portfolios and how it’s going to impact their spending in terms of rising prices at the pump [and] at the grocery store,” he said.