Consider Commodities After Broad-Based Price Strength

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Daniel Greenspan, CIBC Asset Management, senior analyst and resource team director.

As the global economy recovers, we’ve seen some shortages in various raw materials. Over the past year, these shortages have driven commodity prices to multi-year highs as demand has rebounded and supply has not been able to keep up.

It’s also worth noting that supply-demand mismatches have been widespread, and commodity prices have been strong almost across the board. This ranges from soft commodities like corn and soybeans to lumber, to steel, to base metals and to energy.

In recent weeks, the market tightness that drove prices higher has taken a bit of a pause, and commodity prices have come off of highs, but they do continue to trade at a very healthy level.

In the near term, price direction for commodities is somewhat uncertain. Demand remains reasonably good and supply is fine, but policy changes in key end markets like China are having an impact on prices.

In metals, specifically, China is working to curb speculation and manage prices lower in the short term, which has weighed on the sector in recent weeks. Most recently, we’re seeing risks around release of strategic reserves from Chinese stockpiles, which could put more tons into the market for aluminum, zinc and copper and into the hands of end users, which could help balance the market and should pressure prices.

That said, with the reopening of other developed economies around the world like the U.S. and the European Union, there should be a pickup in demand from other regions that should be supportive for commodity prices. But given its size, China’s impact on commodity markets will remain a key driver.

In terms of where we’re bullish on commodities into the second half of the year and into 2022, we like the outlook for oil. OPEC continues to manage supply and U.S. producers are showing discipline as investors continue to push them for a return of capital rather than growth. From the demand side, we view oil as a good way to play a reopening trade and we expect industrial production, miles driven and air travel to ramp up as vaccination rates gather pace.

In metals, we’re watching copper closely and we see opportunities to buy closer to $4 a pound for investors who have a medium to longer-term view.

There are a few other more niche commodities where we like the outlook into the second half of 2021 as well. And that includes steelmaking coal and fertilizers like potash. For steelmaking coal, global trade flows have been disrupted by a dispute between Australia and China. As India and Europe ramp up steel production and demand increases, we expect seaborne metallurgical coal to benefit as the displaced tons from Australia find new homes and the market balances.

On the fertilizer side, strong crop prices, particularly in corn and soybeans, have made farmer economics the strongest they have been in years. We expect that farmers making planting decisions this year will look to maximize the yield on the acres they plant, which means full allotment of fertilizers including potash. At the same time, the supply side for potash remains well-managed and some of the incumbent producers have been experiencing supply issues, and there’s some risk around sanctions on Belarus taking potash volumes out of the global market.

In terms of the equities that we think can be invested in to express our view on the commodity market outlook, we’ll highlight a couple of stocks that we think are interesting. First in energy, we like the outlook for Cenovus. This is a company that’s integrating the newly acquired Husky assets into the portfolio, and that process is going very well. They’re making the necessary adjustments to get the most out of the new assets. At current commodity prices, we expect Cenovus to meet leverage targets in the near term. And we think that after that, free cash flow could be allocated to a share buyback or modest dividend increases, which would help support the stock.

We see potential for asset sales that could further support the balance sheet and modestly simplify the business as well. The capital allocation strategy resonates well with us, and we think the stock could outperform in the second half of 2021.

In base metals and steelmaking coal, we like Teck Resources. Teck is a company with a few catalysts coming up aside from the commodity prices that we think can drive the stock over the next year. Teck is ramping up a port expansion at its Neptune facility in British Columbia that could bring down costs in its coal business.

The company is also moving forward with construction of its large-scale QB2 project in Chile. As this major new mine gets closer to production, we expect the stock to rerate to reflect the potential of this asset in the portfolio. We also see potential for asset sales, which could include development stage copper projects and its stake in the Fort Hills oilsands project. Teck’s balance sheet is in good shape and the valuation on the stock remains reasonable.

In the fertilizer sector, we like Canadian producer Nutrien with a sizable business in potash, nitrogen and retail. The company is well-positioned to benefit from strong farmer economics both through its wholesale fertilizer business and through its retail network. The company has unused capacity in its potash business that can be ramped up to meet demand in a strong potash price environment, which we are seeing today. The balance sheet’s in very good shape, the capital return program is strong, and we see upside potential to annual guidance when the company reports second-quarter results later in the summer.