Tag Archive: commodities

Big divergences in commodity space still favor Materials over Energy

One of the themes in our sector research for clients recently has been to focus on relative preferences within broader style or macro categories, rather than making big macro bets on Growth versus Value or Cyclical versus Defensive areas. We find that in a more range-bound market with conflicting macro trends, a more granular view is often more effective.

One stance we have held for some time has been within the Value-oriented commodity space. While in many cases historically the Energy and Materials sectors have moved together, this year has seen a dramatic divergence between the two commodity-related sectors. We have favored Materials over Energy this year, and still do, and below are some of the drivers of that view.

The first chart below shows the returns of the S&P 500 Materials sector and the S&P 500 Energy sector for this year, along with the relative performance (all indexed to 100 at the start of the chart), as of October 27th.SP500 Materials vs Energy Sector Returns

The collapse of the Energy sector this year has been historic, and comes after less extreme underperformance that was already occurring in 2019. The S&P 500 Energy sector total return index has declined -50% this year, by far the worst performing of the 11 major sectors in the S&P 500. This compares to the 6.5% gain for the S&P 500 overall.

The Materials sector, despite also being tied to global economic turbulence and commodity prices, has held up far better. Its year-to-date gain of 5.6% is only marginally behind the overall index, and vastly higher than that of Energy. And the relative outperformance trend has been consistent most of the year, both before the COVID-19 volatility in March and afterwards.

What explains the performance gap in these two commodity sectors?

First, the underlying commodities they are most closely tied to have followed very different paths this year. Crude oil prices are still far below their level at the start of the year (down about 40% for benchmark Brent crude), and even the current level of oil prices relies on the aggressive production cuts put in place by oil producers globally. So oil producers are facing the combination of lower prices and lower production, causing a severe drop in revenues. Naturally, the effects of severely depressed fuel usage due to COVID-19 travel limitations are a major factor in oil demand, and remain in place.

By contrast, industrial metals prices such as copper, aluminum, zinc, etc. (represented by the S&P/GSCI Industrial Metals index) have fully recovered their COVID-related decline and then some. Resurgent demand from China in particular as well as the strong US housing market have helped support prices for these metals used in manufacturing and housing, and are benefiting from the reflationary efforts of global central banks. Along with the increases in precious metals prices (gold and silver) this year, many of the stocks in the Materials sector have a relative tailwind to earnings from commodity prices.

Oil Industrial Metals

The effect of these divergent commodity price trends is also showing up in relative earnings estimate revisions activity. Analysts have been much more inclined to raise their earnings forecasts for Materials companies than for Energy companies, and that remains the case today. The chart below shows our aggregated relative earnings estimate revisions metrics for Materials versus Energy in the US. Readings above zero on the chart indicate more favorable analyst estimate revisions trends in Materials relative to Energy (red line indicates the relative proportion of analysts raising vs. lowering estimates, right scale; the blue bars indicate the average relative percent change in consensus estimates for the next 12 months, left scale). We can see that the readings are strongly in favor of Materials over Energy and have been for several months now.


With fundamental trends and relative returns both still pointing toward Materials over Energy within the commodity space, we would maintain relative positioning along those lines.

Risk on? Not really since early June

In financial markets, it seems like “everything” is going up recently. Stocks, bonds, precious metals, even Bitcoin. Perhaps that should not be surprising given the huge amount of liquidity being produced by global central banks in addition to the fiscal stimulus earlier this year. That tends to have the effect of pushing asset prices up generally.

But when we look at relative returns of some key assets, it looks more like the “risk on” trend has not really gone anywhere since early June. That is, owning the riskier option within various asset classes has not generated excess returns to compensate for that extra risk since the recent peak in risk about June 8th.

As shown in the chart below, buyers of risk in many areas have not been rewarded for about two months now (shaded area since June 8th). Brief comments on each section of the chart are below it.

This could be a natural consolidation after a surge in return to risk after the late-March lows, or a sign that the impact of stimulus, and stimulus itself, is fading.  Many prices/valuations are back near pre-COVID levels even while the economy and earnings are still far weaker than they were in January. Uncertainty about additional fiscal stimulus, now that much of it has expired or been spent, and worries about the continued aggressive spread of COVID-19 in the US are potentially countering the positive hopes for vaccine developments and ongoing central bank support.

We will be watching these returns closely for indications of whether investors are getting properly “paid” for taking on additional risk.

High vs Low Risk Relative Return Measures

  • Top section: Global stocks, measured by the MSCI All-Country World Index (ACWI) have performed no better than long-term US Treasury bonds since early June, and are still far behind bonds on a year-to-date basis.
  • 2nd section: Similarly, within the fixed income market, long-term Baa-rated US corporate bonds have done no better than long-term US Treasuries since early June (despite the ongoing support from the Federal Reserve), and remain well behind Treasuries for the year-to-date.
  • 3rd section: High-beta stocks in the S&P 500 have lagged low-volatility stocks in the index since early June, even as the S&P 500 itself has moved somewhat higher.
  • 4th section: US small-caps have lagged large-caps since early June, and small-caps remain significantly more volatile.
  • Bottom section: Among commodities, industrial metals (copper, aluminum, zinc, etc.) that are used in manufacturing are typically a measure of global growth that rise when the economy is improving (“risk on”). Precious metals are more often preferred as an inflation or currency hedge (“risk off”). So while both industrial and precious metals prices have individually risen significantly recently, industrial metals prices have lagged those of precious metals since June.