Commodity sector shines as Coca-Cola confirms inflationary pressures

Equities 8 minutes to read
Peter Garnry

Head of Equity Strategy

Summary:  Our commodity sector basket is doing great thriving under inflationary pressures building everywhere in the global economy. Until now the market has priced commodities higher and a little bit of inflationary pressures in break-even rates, but equities have mostly dodged the bullet. But Coca-Cola yesterday confirmed that commodity inflation is real and becoming a big threat soon to the bottom line. This is indicator to watch going forward. In today's equity update we also take a look at IBM earnings and talk about which equity theme baskets we are working on.


Our commodity basket, that we introduced in early January in addition to making inflation and the commodity sector our top pick in 2021, continues to perform well up 0.3% in an otherwise difficult trading session for equities overall. The commodity sector basket is up 18% year-to-date with the biggest gains coming from the agricultural and metals & mining stocks. Today, Vale announced a big miss on iron ore production fueling more momentum in the already hot iron ore rally highlighting that inflationary pressures are driven by many production bottlenecks in the global economy.

The best performing stock in the basket is Lynas Rare Earths which is a miner of rare earth minerals which is currently experiencing a renaissance and repricing because the US has made it a strategic objective to reduce the reliance on Chinese production favouring non-Chinese producers. Rare earths minerals are heavily used in the technology sector as thus experiencing increasing demand as the world is hungry for computer chips. China has acknowledged the threat from the US and is urging the world to cooperate on rare earth production.

Source: Bloomberg

Coca-Cola also confirmed yesterday on its Q1 earnings conference call that the commodity environment is challenging the next 12-18 months with the biggest inflationary pressure in commodities such as plastic, aluminum, juice, and coffee. The beverage company said that it can control inflation in 2021, but that next year will be a challenge. As inflationary pressures continue into 2022 it will start a ‘hunger game’ as companies will be forced to choose whether to reduce margins or pass on the rising input costs to the consumer with the risk of losing market share. The companies with market power in their industry are the ones with the greatest strategy flexibility and also why we recently introduced our mega caps theme basket, as these companies have the strongest businesses, best brands, and the largest profit margins. Hence mega caps should also do well during inflationary pressures relative to other companies.

IBM transition to cloud is still in slow-motion

The old technology giant IBM excited investors yesterday with their Q1 earnings pushing the story about its Cloud and Cognitive Software segment seeing double-digit growth rates. However, the segment is still only 31% of the business up from 28% two years ago. The transition for IBM is under way but it is really slow and will continue to put a lid on the company’s valuation metrics which otherwise look quite attractive in a world of low yields. The free cash flow yield is currently around 10% which is quite unusual for this type of business, but also highlighting how much narratives mean for your valuation.

Upcoming equity themes

According to the International Energy Agency (IEA) the world will see a major increase in carbon emissions this year as the world economy rebounds driven by rising coal demand in Asia expected to reach levels not seen since 2014. The world is desperately short on reaching its goal of reaching net zero carbon by 2050 as coal is still the cheapest energy source available when you exclude negative externalities such as air pollution and impact on the climate more generally. As long as, the world does not have a global carbon emission mechanism like the one in the EU, the developing countries will continue to adopt coal for electricity production for many years.

In late March, Reuters had a story on EU moving closer to designate nuclear power as a green energy source thus qualifying for government programmes to deliver the green transformation. Our view is that the world eventually adopts nuclear power again (building out new net generation capacity) and create a renaissance for this efficient energy source. Why is this needed? Because the system costs increase as renewable energy sources increase in weight on the grid, so we need an efficient base load energy source. In the transition natural gas will be used due to low cost and high energy density, but this energy source still emits carbon emissions unless it is combined with the expensive carbon capture storage technology, and thus we believe nuclear power is a natural extension.

As a result, we will soon be launching a nuclear power theme basket to track this industry and the pricing action better. On top of this theme, we are also working on a financial trading theme basket consisting of exchanges, brokers, market makers and financial data firms. We are also working on a Millennials theme basket, but this is a more complex one to do, but fascinating and something that spans many different industries like our green transformation basket. Finally, we are looking at creating a rare earth and semiconductor theme basket.

Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide and Product Disclosure Statement to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.
Please click here to view our full disclaimer.