At a stock level, commodity stocks have become the best performers, in the US and Australia this year. Oil and gas, and crop nutrient companies are strongly outperforming markets. Oil companies like Occidental Petroleum (OXY) trade 104% higher this year, Halliburton (HAL) is up 60%. While Fertiliser companies like Mosaic (MOS) have gained 73%, CF Industries (CFF) is up 43%; all sharply outperforming the US benchmark S&P500 which is underwater, down 12% year to date.
Five other catalysts to invest in commodities?
Consideration 1 - wage inflation and supply issues - Some of the largest companies in the world, Amazon, Tesla, IBM, BHP, Rio etc are flagging wage inflation and supply issues will linger throughout this year. Some companies like Tesla and IBM, will be passing costs onto consumers, while also experience slimmer margins. IBM and many other companies have stated this.
Consideration 2 – overall earnings is slowing, but not in commodities - US quarterly earnings results showed earnings stalled in the first quarter 2022, with earnings growth coming in about 70% below the historical average amid wage inflation and supply chain issues. Overall earnings growth in Q1 is just 2.6% (out of the 275 S&P500 companies who reported results so far), and this is below the 10% average for earnings growth. The strongest earnings growth has come from the Energy sector with 245% average earnings growth in Q1, and the Materials (mining) sector with 37% earnings growth.
Consideration 3- higher interest rates to come -The Fed alluded to doing what it can to ‘fight inflation’ last year (November 2021). Since, then inflation surged to 40 year high (8.5% year on year in March). Inflation surpassed the Fed’s forecasts, and inflation is set to continue, and thus The Fed will hike rates aggressive to combat this. This week the Fed is expected to make a 0.5% rate hike (its biggest hike since 2000). The Taylor rule, the Fed’s model to forecast interest rates, suggests rates should be 9%, not 2.6%, where consensus forecast rates to be at year-end.
Consideration 4- The market favours quality companies- Companies, specifically commodity companies, with strong balance sheets, scale, and strong free cash flows have been favoured this year, and this trend will likely continue as these organisations can sustain rising inflation and rising interest (click here for commodities stock inspiration). The market is already telling us this; favouring those who will likely do well over the next 6, 9, 12 months (commodities)
Consideration 5- G-7 countries to shrink their balances sheets by $410 billion in 2022. Yet Commodity companies have enough cash flows for buy backs. Many commodities companies have ample free cash flows, and are likely to announce buy backs. On top of that, many companies have solid valuations in comparison to their earnings. Even if the war is Ukraine is over tomorrow, cash flows, and free-cashflows, in commodities companies are still aggressively rising, not only due to due to US President Biden’s infrastructure stimulus, but also China’s stimulus. Rising cashflows, and earnings are said to be the key to share price growth, especially in this new market of record inflation and rising rates.
Potential sectors and stocks to watch?
Global lithium prices are likely to set new records this year. The Lithium Price Index (a measure of the lithium prices) is at its highest level in history, supporting lithium stocks share price growth. We believe the lithium price is likely to set higher prices this year, given the supply deficit, and rising demand from electric vehicle companies who are phasing out internal combustion engines (ICE or IC engines). Morgan Stanley is also of the same view too. Meanwhile, Morgan Stanley is bearish on the lithium price in 2023, seeing a return to surplus lithium next week. We think the lithium price could set higher levels not just this year, but over the longer term given the lack of supply, and higher the International Energy Agency (IEA) wants to ban fuel consumption engine sales by 2050.
Stock to watch? Sociedad Quimica y Minera de Chile (SQM)
SQM is one of the world’s leading lithium companies, while diversified in plant fertilizers too. 41% of its profit is from lithium. While it produces fertilizers and plant nutrients including potassium, and as well as other agricultural sector products where 57% of profits are from. Both lithium and fertilizers are growth markets. The lithium carbonate price is tipped to grow at 17% CAGR till 2026. Fertilizers are also tipped to see strong CAGR’s for the world to grow crops, and also sustain higher growth rates due to the behavioral shift toward eating vegan/vegetarian product. For more on fertilizers, click here.
- Key Metrics: SQM is listed in US. Market cap is $21 billion. P/E is 11.78 times earnings. Current yield is 0.5%.
- Outlook? SQM is likely to hit higher levels this year, supported by expectations for the lithium price to double, and for fertilizer/agricultural nutrient prices to continue to rise amid rising demand and limited supply (Russia has a ban on phosphorus and potash and China has limited exports of phosphate). The market (known as consensus) expects SQM’s revenue and gross profits will hit a record this year as a result. Revenue growth of 111% is expected, profit growth of 50% is expected, and earnings (EBITDA) growth of 51% is expected.
- The technical indicators: Are bullish, on a weekly and monthly level, suggesting SQM’s share price could set new highs to the delight on long term shareholders and new investors.
- Key risks: Supply chain issues and higher wages could be a headwind for the short term.