The commodity sector and the reflation trade in 2021 The commodity sector and the reflation trade in 2021 The commodity sector and the reflation trade in 2021

The commodity sector and the reflation trade in 2021

Equities 6 minutes to read
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.

Source: Bloomberg

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.

NameCategorySub-categoryMarket cap (USD, mn.)
Deere & CoAgricultureMachinery84,310
Corteva IncAgricultureSeeds and crops protection28,981
Archer-Daniels-Midland CoAgricultureIntegrated agribusiness28,048
Nutrien LtdAgricultureAgricultural chemicals27,479
Kubota CorpAgricultureMachinery26,281
Bunge LtdAgricultureIntegrated agribusiness9,159
WH Group LtdAgricultureMeat processing12,780
Wilmar International LtdAgricultureIntegrated agribusiness23,022
Muyuan Foods Co LtdAgriculturePigs and feed products49,179
Inner Mongolia Yili Industrial Group Co LtdAgricultureDairy products44,571
Ingredion IncAgricultureSweeteners and starches5,270
Linde PLCChemicalsIndustrial gas138,139
Air Liquide SAChemicalsIndustrial and health care gases79,665
BASF SEChemicalsDiversified chemicals74,515
Air Products and Chemicals IncChemicalsIndustrial gas60,395
DuPont de Nemours IncChemicalsDiversified chemicals52,184
Wanhua Chemical Group Co LtdChemicalsDiversified chemicals45,722
Chevron CorpEnergyIntegrated oil & gas162,568
Exxon Mobil CorpEnergyIntegrated oil & gas174,288
Royal Dutch Shell PLCEnergyIntegrated oil & gas139,524
TOTAL SEEnergyIntegrated oil & gas114,571
PetroChina Co LtdEnergyIntegrated oil & gas111,504
Enbridge IncEnergyTransportation65,001
Neste OyjEnergyRefining and marketing56,825
ConocoPhillipsEnergyExploration and production42,711
Phillips 66EnergyRefining and marketing30,550
Schlumberger NVEnergyOilfield services and equipment30,388
Koninklijke Vopak NVEnergyTank terminal operator6,692
BHP Group PLCMetals and miningIron ore and copper156,747
Rio Tinto PLCMetals and miningIron ore and aluminium131,659
Vale SAMetals and miningIron ore88,568
Southern Copper CorpMetals and miningCopper50,343
Newmont CorpMetals and miningGold48,113
MMC Norilsk Nickel PJSCMetals and miningPalladium, nickel and copper52,015
Anglo American PLCMetals and miningPlatinum, Copper and iron ore44,118
Glencore PLCMetals and miningEnergy and metals45,548
ArcelorMittal SAMetals and miningSteel26,871
POSCOMetals and miningSteel21,730
MP Materials CorpMetals and miningRare earth minerals5,016
Lynas Rare Earths LtdMetals and miningRare earth minerals2,908

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.



Source: Bloomberg

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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