Commodities

Are commodities the new tech stocks?

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Tech stocks have had a difficult 2022 so far. After a spectacular couple of years during the depths of the pandemic, numerous tech stocks have dropped significantly since the beginning of January.

Commodities have taken over where tech has left off. High prices for oil, copper, and other basic materials have pushed the prices of commodities stocks up.

All of this raises the question: are commodities the new tech stocks?

Commodities stocks

At one level, commodities stocks are easy to understand. Businesses make their money by mining raw materials from the earth and selling them to customers.

Since one mining company’s product is no different from the next, commodities businesses don’t typically have pricing power. Nobody is going to pay more for oil from BP than they would for oil from Shell.

The best commodities businesses are therefore the ones that can keep their costs down. Being able to extract more product and ship it at a lower cost means bigger profits for the mining company.

In general, commodities stocks do better when the price of their product is high. Higher prices allows them to charge their customers more and enables them to increase production.

Take Endeavour Mining as an example. It owns the Wahgnion mine, from which it can extract gold at a cost of between $1,050 and $1,150 per ounce. 

With the gold price currently at $1,853, Endeavour can expect to make around $753 in profit for every ounce of gold it mines. If the price of gold reaches $1,986 – as it did in 2020 – then Endeavour’s profits per ounce increase to around $886.

On the other hand, if the gold price falls to its January 2019 level of $1,287, then Wahgnion becomes much less profitable. And if the price of gold falls below $1,050, the company has little incentive to keep the operation running at all.

The outlook for commodities stocks

Commodities businesses have benefitted from favourable macroeconomic conditions recently. Supply shortages coming from political tensions and strong demand due to loose monetary policy has resulted in persistently high prices. 

This is why commodities stocks have performed so well since the start of the year. The question is whether they can continue to have the kind of roaring success that tech stocks saw during the depths of the pandemic.

I think that this is likely to vary from one commodity to another. In the case of oil, I expect that the political situation that is causing supply constraints will endure for some time, keeping prices high and generating strong results for oil companies.

With other commodities, I think the situation is different. I’m expecting more cyclicality with iron ore, for example, as rising interest rates dampen demand for consumer products and the inventory of finished goods increases.

Conclusion

Commodities stocks are quite different to tech stocks. With no pricing power, the best businesses are the ones with the lowest costs.

Over time, I think that the price of different commodities will rise and fall and I expect commodities stocks to do the same. As a result, I’m biding my time before making a move into stocks that mine raw materials.

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