Exposure to long-term growth in commodities
It is possible that commodities prices will continue to rise for the next 5-10 years on the back of:
- Monetary and fiscal stimulus in the largest countries (1-2 years)
- The post-pandemic rise in spending (1-2 years)
- Underinvestment in various commodities sectors for many years (2-5 years)
- Global population ageing (decades)
- Growth of economies in Asia and Africa (decades).
(You can download the full version of the article with graphs and tables below.)
Monetary and fiscal stimulus in the largest countries
Economic stimulus could continue for another one to two years. Trillions of US dollars have been injected and spent by authorities in numerous countries, with further trillions on the way, according to recently announced measures. Major central banks are in no rush to hike interest rates. All this is likely to be pro-inflation, which is good for commodities prices.
The post-pandemic rise in spending
Many experts predict this to happen. JPMorgan expects a USD 1 trillion rise in consumer spending per year once people return to post-COVID ‘normal’. McKinsey’s research suggests that “more than 50 percent of US consumers expect to spend extra by splurging or treating themselves”. Experts from the McKinsey Global Institute believe there is likely to be a rapid rebound of consumer spending once the world returns to normal.
Underinvestment in various commodities sectors for many years
Experts from Shroders see the current situation as resembling that at the start of the century. Underinvestment in commodities sectors in the 1990s was one of the key factors for commodities growth during the period from 2000 to 2007.
Charles Goodhart and Manoj Pradhan in their book “The Great Demographic Reversal: Ageing Societies, Waning Inequality and inflation revival” argue that future demographic trends will be pro-inflationary. The intuition behind their argument is that once the number of dependents (who do not work but do spend) grows faster than the number of workers, the environment becomes inflationary, and vice versa. In the coming decades, the dependency ratio (dependents to workers) is likely to grow mainly due to population ageing and slow work force growth.
Growth of economies in Asia and Africa
The expansion of Asian and Africa economies can help boost demand for commodities, just as the expansion of China’s economy did in the period 2000-2007.
Long-term commodities price growth should be great for commodities producers. From 2000 to 2007, the MSCI Russia index returned a cumulative 700%+ in US dollar terms vs 200% for the MSCI EM index and 30%+ for the MSCI World (DM) index.
We believe there is huge potential for a re-rating of commodities producers’ stock prices. The new commodities super-cycle is far from being the consensus view: we are seeing backwardation on the commodities futures market. A re-rating of commodities producers’ stock prices could occur if the futures market turns out to be wrong.
The Russian equity market has a 50% overweight in commodities compared to the broader EM index. This overweight in commodities is more diverse than in the past: 22% in materials and 28% in energy now vs. 4% in materials and 30% in energy 10 years ago.
Sustainable macroeconomic situation. In 2020, Russia came through the COVID-19 test ‘relatively well’ despite the 36% YoY drop in average oil prices. This is comparable to what happened in the 2008-2009 Global Financial Crisis. The main reasons for such resilience include a decade of efforts by the Russian authorities to limit the exposure of the Russian economy to external shocks through inflation targeting, tight control of budget spending, its budget rule and low debt in the corporate and government sectors.
‘Cash cows’ dominate the Russian market. The expected free cash flow (FCF) yield for the Russian market is 11% on average for the next three years with an expected dividend yield of 8%. This is far above the expected average inflation of 4%-4.5%.
Potential for some evaporation of sanctions risk
The market believes that the risk of material sanctions has increased with Joe Biden becoming US President. Since August 2020, this has cost the Russian market around 10% in relative underperformance vs. the broader EM index. Biden has always talked tough in relation to Russia.
Contrary to the market consensus, we believe the risk of material sanctions against Russia has not changed with Biden becoming president. So far, Biden’s actions have been much softer than Trump’s.
Overall, the main reason why there have been no material Iran-style sanctions against Russia since 2014 is the fear of a ‘boomerang effect’. This is still in play. Russia is much more integrated into the global economy than Iran.
The launch of the Nord Stream-2 gas pipeline could be a trigger for the market to realise that Biden’s election has not changed the risk of material sanctions. As of the end of March 2021, around 95% of the Nord Stream-2 gas pipeline was completed. The pipeline is likely to be fully completed this year.
With a 50% overweight in commodities compared to the MSCI EM index, the Russian equity market gives exposure to possible global commodities market growth. During the previous growth trend in the commodities markets – 2000-2007 – the Russian equity market rose by more than 700% in USD terms. The Russian market’s overweight in commodities is more diverse than in the past: 22% in materials and 28% in energy now vs 4% in materials and 30% in energy 10 years ago.
In addition, the Russian market is likely to benefit from high dividend yields, resilience to economic shocks and likely partial evaporation of sanctions risks.
Authors: Vladimir Tsuprov, CIO; Egor Kiselev PhD, Head of International Business & Investment MarketingRussian equities riding the long-term commodities growth trend May 2021