Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The commodity sector and the reflation trade in 2021
Peter Garnry
Chief Investment Strategist
Summary: The commodity sector in equities is an interesting alternative to inflation hedges normally carried out in gold, TIPS and real estate, because it gives you access to companies with experience in the underlying physical commodities providing a roll yield on top of productivity gains and cash flows. In this equity update we introduce our commodity sector basket consisting of 40 stocks across agriculture, chemicals, energy, and metals & mining providing an inspirational list of commodity stocks that investors could consider in order to get exposure to the commodity sector. This part of the equity market outperformed global equities back in 2016-2018 when inflation was running high.
We wrote and talked about the reflation trade in the last three months of 2020 with its implications for emerging markets and the value rotation. This year has started with a big jolt from commodities as we write about in today commodity update Commodities bolt out of the gates to kick off 2021 driven by vaccine rollout, tight supply chains, weaker USD, excess stimulus and speculative demand for inflation hedges outside the classic trades such as long gold and long TIPS. The aggregate roll yield across many commodities has also reached the highest levels since early 2014 indicating a structural change and a new market dynamic. The latest update on underlying inflation from the NY Fed, which considers both physical and online prices across many categories, is also flashing continued inflationary pressures after inflation hit its flow in June 2020.
Our commodity sector basket aims to provide a list of broad exposure to the global commodity sector. The basket comprises of 40 stocks across four categories such as agriculture, chemicals, energy, and metals & mining. We have for the most part chosen the largest companies in each category but have had to deviate a bit from that principle to get a diversified basket of stocks. We also aimed at diversifying across different regions of the world to avoid getting a high concentration in a specific country.
| Name | Category | Sub-category | Market cap (USD, mn.) |
| Deere & Co | Agriculture | Machinery | 84,310 |
| Corteva Inc | Agriculture | Seeds and crops protection | 28,981 |
| Archer-Daniels-Midland Co | Agriculture | Integrated agribusiness | 28,048 |
| Nutrien Ltd | Agriculture | Agricultural chemicals | 27,479 |
| Kubota Corp | Agriculture | Machinery | 26,281 |
| Bunge Ltd | Agriculture | Integrated agribusiness | 9,159 |
| WH Group Ltd | Agriculture | Meat processing | 12,780 |
| Wilmar International Ltd | Agriculture | Integrated agribusiness | 23,022 |
| Muyuan Foods Co Ltd | Agriculture | Pigs and feed products | 49,179 |
| Inner Mongolia Yili Industrial Group Co Ltd | Agriculture | Dairy products | 44,571 |
| Ingredion Inc | Agriculture | Sweeteners and starches | 5,270 |
| Linde PLC | Chemicals | Industrial gas | 138,139 |
| Air Liquide SA | Chemicals | Industrial and health care gases | 79,665 |
| BASF SE | Chemicals | Diversified chemicals | 74,515 |
| Air Products and Chemicals Inc | Chemicals | Industrial gas | 60,395 |
| DuPont de Nemours Inc | Chemicals | Diversified chemicals | 52,184 |
| Wanhua Chemical Group Co Ltd | Chemicals | Diversified chemicals | 45,722 |
| Chevron Corp | Energy | Integrated oil & gas | 162,568 |
| Exxon Mobil Corp | Energy | Integrated oil & gas | 174,288 |
| Royal Dutch Shell PLC | Energy | Integrated oil & gas | 139,524 |
| TOTAL SE | Energy | Integrated oil & gas | 114,571 |
| PetroChina Co Ltd | Energy | Integrated oil & gas | 111,504 |
| Enbridge Inc | Energy | Transportation | 65,001 |
| Neste Oyj | Energy | Refining and marketing | 56,825 |
| ConocoPhillips | Energy | Exploration and production | 42,711 |
| Phillips 66 | Energy | Refining and marketing | 30,550 |
| Schlumberger NV | Energy | Oilfield services and equipment | 30,388 |
| Koninklijke Vopak NV | Energy | Tank terminal operator | 6,692 |
| BHP Group PLC | Metals and mining | Iron ore and copper | 156,747 |
| Rio Tinto PLC | Metals and mining | Iron ore and aluminium | 131,659 |
| Vale SA | Metals and mining | Iron ore | 88,568 |
| Southern Copper Corp | Metals and mining | Copper | 50,343 |
| Newmont Corp | Metals and mining | Gold | 48,113 |
| MMC Norilsk Nickel PJSC | Metals and mining | Palladium, nickel and copper | 52,015 |
| Anglo American PLC | Metals and mining | Platinum, Copper and iron ore | 44,118 |
| Glencore PLC | Metals and mining | Energy and metals | 45,548 |
| ArcelorMittal SA | Metals and mining | Steel | 26,871 |
| POSCO | Metals and mining | Steel | 21,730 |
| MP Materials Corp | Metals and mining | Rare earth minerals | 5,016 |
| Lynas Rare Earths Ltd | Metals and mining | Rare earth minerals | 2,908 |
Source: Bloomberg and Saxo Group
The interesting part of investing in the commodity sector through equities is that it provides investor with exposure to productivity gains, automatic handling of rolling in commodities and provides a leveraged play on reflation.
The performance of the basket is shown below against the MSCI World Index in USD. Since inception on 1 January 2016 the portfolio is up 171% including dividends compared to MSCI World up 83% during the same period. In terms of relative outperformance our commodity sector basket has delivered around 90% relative outperformance with almost 70%-points of the outperformance coming from the period January 2016 to June 2018. This corresponds well with the period of rapidly rising inflation according to the NY Fed Underlying Inflation Gauge highlighted in the beginning. If we are right about rising inflation the commodity sector in general should see increased revenue growth and higher profitability combined with higher valuation multiples.
The key risks in our commodity sector basket are of course a rising USD, lower inflation, and lower economic growth in China. Especially, the last risk source is the most important one as China’s manufacturing sector drives demand for chemicals and metals, and China’s growing wealth drives demand for agriculture and energy.
Introducing themes
Themes incapsulate the equity market in a better way than the traditional country and sector indices due to the more correlated equity markets as a function of globalization. Therefore, we will spend more time on equity themes going forward and our commodity sector basket above is the first step. We will progressively throughout the year introduce more themes and regularly follow up on performance across our podcast and regular analyses.
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