Commodities tend to be the most volatile asset class when it comes to price variance. It is not unusual for the price of a raw material to double, triple, or even halve over a short time horizon. Commodities are global assets, and while supply and demand fundamentals tend to be the primary determinate of the path of least resistance for prices, many exogenous events can impact values. Geopolitical and macroeconomic events, weather, and natural disasters can cause pandemonium in commodities where production is often a localized affair and consumption is ubiquitous. However, commodities tend to respond to macroeconomic trends as an asset class, and from 2011 through late 2015 and early 2016, the majority of raw material prices moved lower.
While consumers benefit from lower prices for staple commodities, producers who invest in output suffer and the pain felt by companies that are in the business of producing raw materials reached an apex during the early days of 2016.
Last week, I published an article on Seeking Alpha entitled, Industrial Commodities Find Bottoms, where I highlight the rebound in the prices of oil, iron ore, copper, and lumber. Today, I am taking a look at the companies that have benefited from higher prices for these and other raw material staples over recent weeks.
The bottom in commodities prices in early 2016 caused lots of house cleaning
The prices of many industrial commodities declined steadily from highs in 2011 until late 2015 and early 2016. The bull market in the raw materials sector caused many producers to increase investment and output during the height of the bull market, but they still had the legacy of those capital expenditures and high levels of debt as prices moved to the downside.
The beginning of 2016 was a rough time for not only the commodities sector but also for equity markets. A selloff in the Chinese stock market caused the S&P 500 index to decline by 11.5% over the first six weeks of 2016, but stock prices found their bottom in February of that year and have been rising since. As stocks fell and raw materials prices dropped to multi-year lows, there was a lot of concern in markets about the financial health of some of the world’s leading commodities producers who found themselves buried under a mountain of debt at a time when revenues from output were declining. In some commodities markets, prices fell to levels that were at or below production costs which had risen dramatically during the height of the bull market. At the bottom, in early 2016, many analysts expressed the concern that some of the biggest producers of raw materials in the world might not survive the swoon in prices. Management of the biggest companies snapped into action by cutting or eliminating dividend payments to shareholders, downsizing staff, lowering output from properties that were producing at a loss, and selling non-essential production assets. Over the course of 2016, producers got their houses in order and have since seen benefits from higher commodities prices.
Raw material prices rose from February 2016 through the beginning of 2017, and the prices of these companies moved higher as revenues increased and debt levels moved lower as a result of their corporate house cleaning. However, the correction to the downside from February through June of this year caused the shares to correct lower. Since late June, we have seen the share values rise as the prices of raw materials are back in bullish mode.
BHP the world’s leading producer rebounds
With a current market cap of over $101 billion, BHP Billiton (NYSE:BHP) is a major global producer of petroleum, copper, iron ore, and coal as well as many other commodities.
As the chart of BHP’s stock shows, the shares reached a multi-year bottom of $18.46 in January 2016 and rose to highs of $41.79 in January of this year. After a decline to $33.42 on June 19, BHP was trading near the 2017 at $41.21 on Friday, August 4.
BHP is perhaps the largest commodities producer in the world, and while copper is trading at a new high in 2017, many other raw material markets are still below their peaks. However, BHP has come all the way back and has posted a 23.3% gain since the middle of June.
RIO moves higher as profit margins grow
Rio Tinto (NYSE:RIO) has a market cap of $80 billion and is a diversified commodity producing company with global production assets in the aluminum, copper, gold, silver, nickel, molybdenum, iron ore, coal, and other metal and mineral markets.
The price of RIO’s stock illustrated, the shares fell to lows of $21.89 in January 2016 and then turned around and rallied back to $47.11 in February of this year before pulling back to $37.66 in mid-June. As of Friday, August 4, RIO was trading at $46.83, a new high for the year and 24.3% higher over the past seven weeks.
GLNCY is the world’s best physical commodities trading company
Glencore PLC (OTCPK:GLNCY) is a major commodity producing company, but they are also the most aggressive raw materials trading operation in the world. The company is the successor of Marc Rich and Company, the firm established in the 1970s by the world’s most notorious raw materials merchant, the now deceased Marc Rich. Glencore produces a broad range of metals and minerals, energy commodities, and agricultural products and it trades most raw materials as the company operates as a merchant. GLNCY has a current market cap of $61 billion.
GLNCY fell to lows of $1.95 per share in early 2016, and many analysts feared the company would not survive given the amount of money it owed to banks around the world. In fact, GLNCY’s exposure to European financial institutions was so great that some believed its failure could trigger a banking crisis in January of 2016. However, the company aggressively addressed its debt position and had done yeoman’s work when it comes to shedding non-essential assets and costs to reduce the liability side of its balance sheet. As the chart shows, GLNCY rose to highs of $8.62 per share in February of this year before falling back to a low of $6.90 on June 19. Since then, the rise in commodities prices has caused GLNCY to rally to a new high for the year at $8.89 per share and was trading at $8.80 on August 4, a 27.5% gain over the past seven weeks.
VALE back from the dead
Vale (NYSE:VALE) is a Brazilian commodity producing giant with a market cap of $50 billion and produces ferrous and nonferrous metals, as well as precious metals and a host of other minerals in Brazil and at locations around the world.
VALE was trading at lows of $2.13 per share in January 2016 and exploded to a high of $11.70 in February 2017. Over the next months, VALE fell alongside the prices of many of the commodities it produces reaching its most recent low at $7.47 on May 15, but since then it has rallied back to $9.97 on August 4, a rise of 33.5% in less than three months.
The total market caps of these four commodities producing and trading giants total around one-third of a trillion dollars. After aggressive cost cutting programs, all of these companies have cleaned house, and their shares have rallied dramatically since the early 2016 lows. The reduction of debt currently puts them in positions to move much higher if commodities prices continue to post gains. The pressure to ramp up output at higher prices could find some facing increasing debt levels if the commodities bull keeps charging forwards, but the experience of 2016 is still fresh in the minds of management at these firms, and the chances are that they will proceed with more caution than in 2011.
The rise in the prices of staple commodities and the shares of the major companies that extract them from the crust of the earth is a sign that the global economy is growing and that inflationary pressures could be just around the corner. While the dollar fell on Friday in the wake of a positive jobs report, a stronger economy is supportive for the prices of industrial metals and the shares of the related companies.
Each Wednesday I provide subscribers with a detailed report on the major commodity sectors covering over 30 individual commodity markets, most of which trade on U.S. futures markets. The report will give an up, down or neutral call on these markets for the coming week and will outline the technical and fundamental state of each market. At times, I will make recommendations for risk positions in the ETF and ETN markets as well as in commodity equities and related options. You can sign up for The Hecht Commodity Report on the Seeking Alpha Marketplace page.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.