Commodity Companies Display Discipline Amid Rally
March 05, 2021
The restructuring by commodities companies during the 10-year commodities bear market is paying off. As many commodity prices reach all-time highs, companies are in strong financial shape and able to give back to shareholders.
Jenna Dagenhart: We're seeing massive fiscal and monetary stimulus measures, supply constraints and increased demand for transitional energy. Joining us now to discuss why many people are eyeing commodities for inflation protection is VanEck Portfolio Manager Shawn Reynolds.
Jenna Dagenhart: Shawn, how have industries and companies reacted to COVID and other issues over the past decade, and how has their financial strength evolved during this period?
Shawn Reynolds: Hi, Jenna. I think the thing that we really need to remember is that most resource companies are coming out of 10 years of a commodity price bear market, which in and of itself was due to the overhang from the super cycle from the first decade of the century. So, they've really responded somewhat aggressively to the COVID situations that exacerbated their circumstances.
Shawn Reynolds: And what has that meant? It has meant that they have been into a massive restructuring, and that restructuring has focused on cutting capital spending, improving operational profitability, and strengthening their balance sheets. And so, as we look at these companies today, they're actually in the best financial shape that I've ever really seen in my career.
Jenna Dagenhart: Now, Shawn, how are they benefiting from the tighter supply demand dynamics?
Shawn Reynolds: Well, as they've gone through this restructuring, as I said, they've really cut back on their capex, and that has led to a supply response. The interesting thing about today—again, comparing it to the last 10 years—is that the demand stimulus that's coming through from monetary and fiscal policies is dramatically different from the previous 10 years, where growth, economic growth was really a headwind. There was this perpetual concern about what was the next crisis going to be after the global financial crisis of 2008 and 2009.
Shawn Reynolds: Now we look forward, we see a COVID vaccine induced possible V rebound. We have massive stimulus on the monetary and fiscal side that are all coming to the market simultaneously, and on a synchronized global basis. And it looks like it's no longer a headwind, but quite possibly a tailwind. So, you combine that with a tightening supply response, and you're seeing commodity prices, across the spectrum. It's not just oil or copper or corn. It's things like rubber. It's like burlap, very basic materials. Prices are on their way up, and in some cases reaching all-time highs. And as I mentioned earlier, the companies are now in great shape to take advantage of that. Whereas even five years ago, or three years ago, if you had strong cash margins from strong cash prices, they had to use that money to pay down debt and fix their balance sheets. Now they're giving that back to shareholders in the form of dividends, special dividends and share buybacks.
Jenna Dagenhart: Given some of these changes, what kind of output can we expect from commodity producers moving forward?
Shawn Reynolds: The real question here is: will they stay disciplined? After going through, again, a 10-year period where they weren't necessarily disciplined or they were suffering from the overhang from the super cycle, will they stay disciplined and keep that supply somewhat restrained, and more importantly, keep themselves in financial strength? And we believe that they are definitely going to do that because a lot of these strategies are just emerging or just becoming quite public. In fact, very recently here we're getting year-end results from 2020. We're seeing dividend announcements that are very, very strong. We had Rio out recently raising their dividend. Their yield has been over 7%. You've had Newmont and Barrick Gold, two of the largest gold miners in the world, announcing special dividends and share repurchases. You've even had oil and gas, E&P companies announce big dividend increases and even variable dividends, which will allow you to participate in any strength that you could see in the oil price or a natural gas price.
Shawn Reynolds: So we really think that these strategies, again, they are new. They're just newly in place, and they're not going to change anytime soon. And they will enforce discipline upon these companies, and so you're going to continue to see that supply restraint.
Jenna Dagenhart: Finally, how will supply constraints impact inflation?
Shawn Reynolds: We're already seeing supply constraints impact commodity prices, and that could very well feed through to inflation. Inflation overall is more than just commodity prices though. It has to do with labor and wage tightness. And we're yet to see that. There's a fair amount of labor slack, and certainly output gaps that we have to work our way through. So, it could be an ideal situation for a commodity, where there's strengths in commodities, yet you don't see headline inflation really spiking. And so, you may not see a reaction from the Fed for quite some time. In fact, they've indicated they won't for quite some time.
Shawn Reynolds: So it could be quite good for the commodity and resource market. And you don't necessarily see, again, headline inflation, but we can continue to see some strength in commodity prices. And once again, can't overemphasize the companies are in great shape to take advantage of that for the first time in many decades.
Jenna Dagenhart: Well, Shawn, great to have you. Thanks for joining us.
Shawn Reynolds: Thanks for having me. Good seeing you.
Jenna Dagenhart: And thank you for watching. That was VanEck's Shawn Reynolds, and I'm Jenna Dagenhart with Asset TV. To receive regular updates from VanEck's experts, please visit vaneck.com/subscribe.
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