Commodities are the new black and your inflation fighting friend

Many investors have seen markets rise over the long-term, while newer investors might be accustom to seeing sharp falls and a quick recovery, almost -V-shape like, which have helped to smooth over market blips. However, the markets in Australia and the US are currently very bearish against a backdrop of rising inflation and the first increases in interest rates in over a decade, which is affecting companies’ ability to make more money.

A protracted market correction looks to be happening, and the recovery is expected to be slow. This is reminiscent of what occurred in 1973, 2000, and 2007, where it took the markets about four years to recover.

So, what can investors consider to ride out the market?

In the next year or so, with inflation, the cost of raw materials and energy are likely to go up, investors could turn to commodity-focused stocks to take shelter in the storm.

The following Three considerations present compelling reasons to invest in commodities:

1- Inflation is an ally to commodities

Some of the largest companies in the world have flagged that wage inflation and supply issues have caused blowouts in expenditures, and have passed cost increases onto consumers, while also accepting slimmer margins. Being at the starting point of production value chains, commodity companies are better equipped to thrive in the current market with earnings growth from the price increase of raw materials being better able to keep pace with costs. Furthermore, central banks are expected to announce more aggressive interest rate rises. This means that inflation is expected to persist and pull up commodity prices.

2- Commodities have been a proven bet

Generally when inflation rises, commodity stocks do well. We saw this since November. In fact, in the first quarter of this year, average earnings in the energy and materials sector have surged, and bucked the trend of declining earnings growth in the general US market. With scale, large commodity companies with strong balance sheets and free cash flows are more likely to withstand the bearish conditions. The market has already begun to appreciate this, with share prices of quality commodity companies being on the up and up.

3- Free cashflows to activate share buybacks

With stellar performances bolstering the earnings and cashflows of some commodity companies, they may conduct share buybacks. This reduces the number of their shares available to the market. This should have a hand in driving up their share prices too.

A key takeaway from all this, is to look out for resource-focused companies who are growing their earnings and cashflows into the future. Some companies that are showing that kind of promise are:

In the US

• Sociedad Quimica y Minera de Chile (SQM shares are up 83% from November)
• Halliburton (HAL shares are up 77% from November)
• Barrick Gold (GOLD shares are up 13% from November)

On the ASX

• BHP (BHP shares are up 30% since November)
• Woodside (WPL shares are up 35% since November)
• Graincorp (GNC shares are up 59% from November)  

In addition, as uncertainty taints the broad market with increased volatility, the US dollar appears to be a good hedge in being the preferred holding currency of investors. There are Exchange Traded Funds (ETFs) that offer exposure to the rising US dollar. Investing in such ETFs may also help to diversify risk.

And lastly, to summarize;  with wealth preservation in mind, now’s the time for investors to turn their focus towards resilient and defensive investments; offering rising cashflows and earnings, as the previously white-hot market spots continue to cool down.

More details on potential market opportunities for 2022, more can be found here.