Commodities: Offsetting risks from inflation & war

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

04 March 2022, 10:00 AM

Sectors Covered:

Mining, Energy

• The emergence of global inflation and geopolitical risks has resulted in rising uncertainty and some weakness across broader equity markets.
• A synchronised boom in energy commodities to this degree is rare, with the fallout for non-resource sectors potentially significant.
• In the current climate we expect prices for oil & LNG, aluminium, gold and coal in particular to keep finding support and stretch consensus expectations.
• We remain bullish on resources believing the accelerating upcycle across major commodities still has some way to play out.
• We upgrade our oil, LNG and aluminium prices (summary further in report).

Hedging against uncertainty

We see resources (physical assets) as offering a great inflation hedge, in particular energy which is also a key inflation source. While several major commodities such as energy resources, base metals and coal have also been directly impacted by the Russia-Ukraine war.

With these key thematics in mind, our investment strategy in resources is focused on oil & LNG, aluminium, gold and coal. While also seeing alternative energy and uranium as ultimately benefitting from current developments.

Resource investors for the most part have already benefitted from the upcycle so far, creating the opportunity for profit taking, but we continue to recommend core exposures are held to the resources sector given current market fundamentals.

Oil price goes vertical

As strong as the oil price has already been, we see no easy answers and expect further upside in the short term. We base this on the ~1mb/d supply deficit prior to the Russia-Ukraine war, and media reports of widespread boycotting of Russian crude since.

If reports are accurate, as much as ~7.5mb/d of Russian oil could be displaced – a quantum of supply that cannot be replaced by an investment-starved global oil industry. An easing of Iranian oil sanctions (on a new nuclear agreement) could see as much as +1.6mb/d of supply although this may not offset Russia.

The uptrend in oil prices has gone almost vertical, with a ~70% increase Brent oil so far in 2022. Current Brent price of US$117/bbl is double the long-term consensus average, dragging earnings from oil & gas producers into an aggressive upgrade cycle. We upgrade our assumptions (further in report).

Our top picks in oil & gas are Santos (ASX:STO) ADD rating (login to view) price target and Karoon Energy (ASX:KAR) ADD rating (login to view) price target.

Other key exposures

Aluminium. Aluminium prices have surged towards record levels above US$1.60/lb on the risk to Russian supply, which accounts for approximately 6% of global supply in an already tight market. We prefer aluminium exposure through diversified miner South32 (ASX:S32) ADD rating and (login to view) target price after upgrading our aluminium assumptions.

Gold. Gold’s fundamentals have not been transformed by the conflict in Europe, but it is a popular safe haven that once again is finding support. We prefer gold for its lower correlation to other commodities and hedging attributes. Our sector preferences in gold have been driven by specific operating risks and leverage. We prefer Newcrest Mining (ASX:NCM) HOLD rating and Ramelius Mining (ASX:RMS) ADD rating as key gold exposures.

Coal. Seaborne metallurgical and thermal coal are trading at significant records (~US$450/t and ~US$400/t respectively). While unsustainably high, we see conditions as supporting coal prices at lofty levels that could outpace market expectations. Our top coal pick is Whitehaven (ASX:WHC) with an ADD rating based on a trading target (bull case) of (login to view) on current coal market strength.

Alternative energy. Not a direct beneficiary of current conditions, but alternative energy resources do typically flourish following periods of extreme price strength in traditional energy resources. Benefitting from demand destruction and increased focus on alternatives. Our top pick is Allkem (ASX:AKE) ADD rating and (login to view) price target.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.