Natural resources: Not just another supercycle

Is rising inflation generated by the economic recovery and stimulus causing another commodity supercycle – or are we experiencing a sustained period of rising demand?

By its very nature, the resources sector is cyclical; fluctuating levels of demand occur at various stages of excess or restricted supply. As such, commodity prices can be extremely volatile. We are now in a period where post-pandemic demand is strong, supply is tight and prices are high. Over time, high prices should encourage new supply and the cycle starts again. However, this could be some years away. Whereas the urbanisation and modernisation of China led to strong demand and a prolonged period of higher prices for many commodities in the early 2000s (the last supercycle), this time the recovery in demand is much more broad-based. This in part reflects a structural change as countries are making efforts to decarbonise to meet Paris Agreement climate change commitments.

Over both the medium and long term, the move toward decarbonisation represents a significant source of new demand and sustained growth for many natural resource companies. This is a tailwind – not just for raw materials, but also across the natural resources supply chain, including logistics and labour.

Describe the role of resource companies and active managers in decarbonisation

While certain areas of the natural resource sector are far from being carbon neutral, they have a unique opportunity to enable carbon reduction. Through company engagement with stakeholders and investors, many natural resource companies are actively seeking to reduce their carbon footprint. Share price performance – all else being equal – is likely to reflect a company's progress along the decarbonisation path. Given the paucity of accurate data, there is a solid argument for active management when it comes to resource investing. Experienced investors should be able to identify businesses that are on the correct pathway. This is evidenced by company commitments allied to capital investment, declining emissions reports, gains from new technology and collaborative news flow between companies, signatories and investors.

What are the key risks for investors within the resources sector at present?

As inflationary pressures build, investors typically seek out precious metals and commodity companies or other cyclical companies that are sensitive to changes in economic conditions. There are some attractive valuations to be found here at present. However, concerns exist. As an example, due to competition between China, Europe and the U.S., there are security-of-supply concerns for copper and lithium. There is a probability that the demand for these metals from manufacturers of electric vehicles or renewable energy equipment may not be readily met, which also comes with broader market implications.

Companies that can be classified as “decarbonisation enablers” (i.e., those that provide raw materials to facilitate carbon reduction) are operating in a backdrop where new commodity supply is limited. As alluded to earlier, for a world-class new copper development, there may be a decade or more between the time of discovery and first production.

More broadly, resource companies in particular are facing increasing pressure in terms of their environmental, social and governance responsibilities as stakeholder demands rise. In response, mining companies and oil and gas businesses are making efforts to reduce carbon emissions and energy usage. For example, some are using renewables such as solar power as a cost-effective alternative to diesel fuel and carbon sinks aiming to reduce the concentration of greenhouse gasses in the atmosphere by planting huge areas of trees.

Given the multitude of factors involved including encompassing regulation, local community needs, supply issues, technology, required expertise and environmental constraints, among others, the path toward “net zero” is both an exciting and challenging one.

How can investors navigate the risks and capitalise on the key opportunities within the sector?

A sensible approach may be one that focuses on high-quality assets and companies that provide meaningful diversification across commodity type, geography and sector. Commodity diversification is important since it is hard to predict commodity price moves, while geographical diversification helps to moderate geopolitical risk. Investors also need to be valuation-aware, with some renewable energy companies trading at extreme valuations. And while investing in resources can be classified as speculative, taking a long-term view is prudent.

Tal Lomnitzer, Senior Investment Manager, Janus Henderson
Tim Gerrard, Portfolio Manager, Janus Henderson