Opportunities for investors after mood shift in commodity markets

Postcard

 

• At commodity conferences in the US, a mood change among industry players was palpable. In the mining sector, the stage is set for a pick-up in mergers and acquisitions.
• Even in agriculture, which continues to face lacklustre farm economics, attitudes are turning more positive.
• Combined with the uncertainty over tariffs, it adds up to a fascinating time for investors in natural resources equities – with new risks to manage, as well as new opportunities to generate returns.

Dawid Heyl, Portfolio Manager

At recent commodity conferences in the US, a mood change among attendees was palpable. While concerns about tariffs surfaced quickly in conversations, the broader sentiment was upbeat, with many delegates scouting for deal-making opportunities. In the mining sector, the focus is shifting from returning cash to shareholders, to growth. Add the fact that miners’ balance sheets are in robust health after several years of relatively strong commodity prices, and we think this environment is conducive to M&A. Most companies are talking to others to consider combinations.

Mining M&A

One reason for doing deals is to offset declining production. We saw this with BHP, the biggest mining house, making an (ultimately failed) bid for Anglo American before (successfully) entering into a joint venture with Lundin Mining to develop major new copper mines in Chile and Argentina. This will help counter a declining production profile at BHP’s largest copper operation, Escondida, at least in the medium term. While production should recover longer term, that will require significant capital investment.

Another reason some mining companies are keen to bulk up is because they feel they lack relevance compared to their end-customers who produce electronics, technology and consumer goods, in terms of both size and pricing power. This is despite the fact that the commodities they mine are essential inputs into these products, and that security of supply is likely to become more challenged over the longer term. This is true for copper and other commodities such as lithium, where Rio Tinto is making a foray into productive assets with the acquisition of Arcadium. Finally, the trends of on-shoring and ‘friend-shoring’ may be accelerated under the new US regime, potentially driving more M&A.

The uptick in corporate activity will not only include full mergers. We are also likely to see more joint operations as miners seek scale advantages and look to use spare processing capacity. A good example is the recent agreement between Anglo American and Codelco, the Chilean state-owned miner, to jointly develop their neighbouring Chilean mines of Los Bronces and Andina. Through the development plan, which will increase annual copper production by almost 120,000 tonnes, the partners expect to generate additional value of at least US$5 billion. Overall, it should be an interesting time for active investors in the mining sector.

Gold tie-ups

M&A is also in the air in the gold sector. Interest in tie-ups was up strongly this year among the gold producers at the conference I attended, partly because large companies are looking to lower their cost profiles after several years of inflation. However, recent transactions have focused on smaller, single-asset targets rather than the mega-mergers of prior years. The difficulties Newmont is having extracting synergies from its combination with Newcrest are still fresh in investors’ minds.

Meanwhile, at current gold prices many gold miners are generating substantial free cashflow, and we see more room for margin expansion and greater cash returns to shareholders. Desire for gold appears to remain strong, driven by fraught geopolitics, uncertainty around fiscal deficits and central banks diversifying out of US treasuries.

Upbeat ags

Our meetings with agricultural input providers – such as suppliers of seeds, fertilisers and crop protection – also suggested a more positive mood. Even though grain inventories remain relatively high and farmer economics are fairly anaemic, farmers still seem intent on planting the maximum area this year. Corn and soybean prices have recovered somewhat, and with fertiliser and chemical prices still low we expect demand for agricultural inputs to remain healthy. Disruption in some commodity input markets such as potash – where outages in Belarus and Laos are anticipated – is also expected to drive price rises. Trade tariffs could be a factor in agricultural commodity markets, but our experience is that a desire for food security usually trumps foreign and trade policy. Countries tend to like to ensure high levels of domestic crop production, hence incentivising farmers to maximise their output.

Tariffs

Tariff talk was not confined to agricultural commodity companies, of course. It was the first topic of conversation in 90% of our meetings. At the moment, it is still mostly just talk – details are lacking. But this is one to watch, as protectionist measures could change the relative advantages of domestic producers vs. low-cost exporters. We heard some surreal stories from some of the major metals industry players we met – such as how little members of the US president’s trade policy team appeared to know about where their country’s supply of aluminium came from.

For me, an overarching theme is emerging: expect greater regionalisation of trade and for domestic commodity producers to receive more support from their governments. It looks like Europe, India and even smaller markets like Brazil will respond to US trade policy by copying many of the tariffs.

While this is likely to create volatility that may be tricky to evaluate at first, it also presents a plethora of opportunities. Armed with knowledge of the supply, demand and trade dynamics in commodity markets, investors have an opportunity to align with the likely beneficiaries of a new order in global trade.

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