The principal risk for natural resources equities is a continuation of the softer demand we saw in 2023. The market will be watching economic data from China – especially regarding Chinese property and fixed-asset investment – particularly closely. That said, it has been notable that, despite mediocre demand in 2023, many commodity prices have held up. So, should demand begin to strengthen in 2024, we would expect upward price pressure on several of the main commodities, and a consequent tailwind for commodity-linked equities.
By sector, we are seeing interesting dynamics among energy equities, where the companies are generating strong free cashflows and are trading at what we regard as appealing valuations. We are also becoming increasingly positive on gold stocks. Geopolitical risk, together with policy tightening likely coming to an end, is creating a supportive backdrop for the gold price. With respect to gold equities, which are leveraged to gold, both valuations and company fundamentals look attractive.
After a year dominated by concerns about the macro outlook, we see a chance for longer-term investors to build positions in natural resources equities. Recent performance has broadly trended sideways. But on a five-year view, we believe this is a compelling entry point.
Natural resources equities can bring several valuable characteristics to a portfolio. The first is potential protection against inflation – historically, commodities have tended to do well when prices are rising – which is clearly relevant today. Second, they may be able to diversify a broad equity allocation. Historically, natural resources stocks have generally moved to the beat of their own drum. Even within the sector, energy, gold, industrial metals and agriculture equities all tend to have different performance drivers. Third, from a valuation perspective, partly because some areas of the sector are out-of-favour, some natural resources companies are trading cheaply – at single-digit price-earnings ratios vs. well over 20x for the S&P 500 Index*.
Finally, natural resources companies are right at the heart of the energy transition. As a result, they offer investors exposure to the powerful economic trends arising from the shift to a low-carbon world. We think the market is misjudging the implications of net zero for natural resources companies, and hence valuations are often distorted.
Arguably, the single most attractive characteristic of natural resources equities right now is what you might call ‘undiscounted change’. In recent years, many equity investors have abandoned the natural-resources sector because they perceive it to be carbon-intensive and to have high environmental, social and governance (ESG) risks. This reflects a deep misunderstanding of the energy transition.
We see tremendous opportunities arising from the move to a low-carbon economy across energy, mining and agriculture. In mining, we think producers of metals like copper, lithium, zinc and nickel all have strong growth tailwinds. In energy, the same is true for those producing green hydrogen and that are actively engaging in the shift to renewables. Similarly, the transition is driving powerful dynamics across agriculture, for example in ammonia and fertiliser production. In short, what the market currently perceives as a negative structural force, in fact has the potential to be a strongly positive impetus for select natural resources companies. If this starts to be reflected in company results and earnings expectations, the sector could see a re-rating.
One important point to make is that we expect widely differing outcomes for individual natural resources companies. Some will flourish in the transition, in particular those able to develop coherent and profitable transition plans. Others will flounder. Consequently, we expect stock-specific risk and opportunities to increase within this sector as the transition progresses. As active investors, we are pretty excited about that.
General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.
Specific risks. Geographic / Sector: Investments may be primarily concentrated in specific countries, geographical regions and/or industry sectors. This may mean that, in certain market conditions, the value of the portfolio may decrease whilst more broadly-invested portfolios might grow. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Derivatives: The use of derivatives is not intended to increase the overall level of risk. However, the use of derivatives may still lead to large changes in value and includes the potential for large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Commodity-related investment: Commodity prices can be extremely volatile and losses may be made. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
*As at November 2023.