There Is Value In Commodity Stocks!

The markets are precariously poised and only time will tell if the Sensex is able to touch new all-time highs in 2021 or whether there will be a deep correction. So far what we have seen is that the market is getting support from different sector stocks on a rotation basis. If banks supported the markets in January and February it is now the commodity stocks that have been providing support over the past few weeks. Yogesh Supekar explains how commodity stocks after their recent outperformance continue to be attractive in terms of valuation and may have some value left, while the DSIJ research team shares its market outlook 




Even as Nifty 50 and Sensex enter into a consolidation phase after some violent moves in both directions, there are stocks from specific sectors that are luring investors with their outperformance. Commodity stocks definitely have caught the fancy of investors after their recent outperformance. There is huge interest amongst investors when it comes to commodity stocks as the conditions are expected to be ripe for them to thrive. Usually, commodity stocks are considered to be proxy for the underlying commodity i.e. if the underlying commodity prices increase it is expected that the relevant commodity stock will gain. When the commodity prices are expected to drift lower, the relevant commodity stocks are expected to underperform.

With the inflation expected to increase as also reflected by rising bond yield both in the US as well as Indian markets, it is a no brainer as to what is expected of the commodity prices. They may get stiffer as we progress into 2021 and that augurs well for commodity stocks across the board. Various research agencies have predicted that the oil demand globally will be back to normal or to the levels seen in December 2019 by early 2022. That means the oil demand will be steady in the coming quarters and one can expect the oil prices to remain steady going forward. Oil prices are already at their two-year highs. It will only be logical to expect the stocks that benefit from rising oil prices to do well in the coming quarters.

Similarly, the prices for other commodities such as zinc, copper, steel, etc. are expected to remain steady. The equity market is forward looking and has already started to discount the effects of rising commodity prices on the commodity stocks. The commodity stocks have been outperforming the benchmark indices by a good margin with several stocks from the commodity stocks’ basket touching their respective 52-week highs, which goes to show the strength of the momentum in prices. If we look at the Nifty Commodity index which has 30 constituents, as many as 17 index constituents have touched their respective 52-week high mark in the first week of March. Four Nifty commodity index constituents touched the important 52-week high prices in February while two constituents of the Nifty Commodity index made fresh yearly highs for themselves in January this year. This goes to show the gaining price momentum in commodity stocks.

Commodity Stocks’ Underperformance To say that the commodity stocks have underperformed would be an understatement. The commodity stocks have heavily underperformed the markets and the extent of the underperformance can be seen in the table below.

Fidelity Global Commodity Stock Fund mentioned in the above table invests at least 80 per cent of the assets in stocks of companies principally engaged in energy, metals and agriculture group of industries. The performance of this actively managed fund reflects the performance of the commodity stocks over the years. Clearly, we can see that the global commodity stocks have underperformed across time horizons. Comments Sanjay Agarwal who regularly invests in technology-driven funds, “The commodity stocks have disappointed for many years. But that does not mean that these set of stocks will keep disappointing every year. In fact, I have a feeling that 2021 belongs to commodity stocks. Technically, the momentum in majority of the commodity stocks is very strong with several stocks trading at or near their respective 52-week highs.”

“I would bet on those commodity stocks where the prices and sales both are close to all-time highs. That way I know I am investing in those commodity stocks where there is price gain backed by solid sales growth. Within the commodity stocks’ basket, one has to be very stock-specific. For example, the sales for cement companies have grown but the profit margins have dropped in the latest quarter. In the chemicals space, there are several small-cap companies that are on the verge of breaking their all-time highs while the steel stocks look like they have a long way to go. The fact that the commodity stocks have underperformed for so long will be a huge advantage in 2021. For sure there is a strong case for commodity stocks to outperform in 2021,” he adds.

Are Commodity Stocks Cheap?

There is an ongoing debate whether the value stocks will do well in 2021 or whether it will be the turn of the growth stocks. Experts believe that value stocks have already started to perform and that they may outperform the growth stocks in 2021 given the extremely high valuation of the growth stocks. If we look at the commodity stocks, there are clear signs of them falling under the category of value stocks. That said, not all commodity stocks may offer value at this point of time. However, there are pockets within the commodity stocks’ space where we can see value. Metals and energy are clearly showing value and by that metrics can be expected to deliver positive returns and beat key benchmark indices going forward. The table below highlights the valuation gaps between various sectors and objectively explains which sectors are trading at a premium and the ones that are trading at discount.

We can see that metal, utilities and energy sector-related stocks are trading at discounts. Thus, valuation may work in favour of the commodity stocks in 2021 as most of the other sector stocks do look overvalued at this point of time. 

Nirali Shah
Head(Equity Research), Samco Securities

Are commodity stocks overvalued?

Commodities are definitely the new flavour of the season and Nifty Metals index has shown a stupendous rally from the level of 1,480 to 4,000 in just a year. In fact, the index is short of 250 odd points from the top it made in 2018 on a monthly chart. Commodities have a cyclical nature and due to their underperformance since 2018, the stocks were ripe for investment during lockdown. The past year of the upward cycle was so swift that investors who missed this rally are now feeling FOMO. But, it isn’t that this growth is going to stop suddenly or dwindle just because some of the stocks are overvalued in this space. In fact, there is still more room for growth in certain pockets such as copper, aluminium, etc. In the past year, some commodities started seeing demand from a structural point of view more than cyclical which could lead to further growth. As demand improves, stocks could see a re-rating in their valuation. For instance, commodities would be a key factor due to the current shortage of semiconductors in the automotive sector, scope for expansion on the electric vehicle front and progress from a technological infrastructure perspective in all other future-led plans. Commodities are also a good play on inflation. Hence investors holding commoditised stocks should continue holding them.

What is your outlook on the equity markets?

Given the tangible recovery underway on the economic as well as vaccine front, equity seems to be a logical place to be invested in. PLI schemes in various sectors, FPI inflows month after month and low interest rates have all led to surplus liquidity in the system which will surely but steadily lead to growth in equities. Hence, buying on dips would be a good strategy for investors to adopt at this juncture. Investors can also opt for SIPs in particular stocks or baskets of stocks which can be a constructive manner of investing consistently to compound one’s wealth.

"Rising global economic growth and growing inflation along with falling dollar are just the kind of conditions required for commodity stocks to outperform. Historically, when the GDP growth has surpassed the unemployment rate, commodities have provided superior returns compared to the key benchmark indices."

Ajit Mishra
VP Research, Religare Broking Ltd.

What is your outlook on commodity stocks?

Commodity stocks have been underperforming for quite some time owing to various domestic and global factors. We have seen a reversal in the trend in recent months thanks to the reopening of the economy, pent-up demand, prospects of businesses shifting from China to India, etc. Going forward, demand is anticipated to remain strong, which bodes well for their growth. Also, companies’ managements are optimistic about future growth prospects. Talking about the valuation part, several stocks like Tata Steel, Hindalco, Nalco, SAIL, Hindustan Copper, etc. have seen decent gains. However, we still believe investors can accumulate stocks such as JSW Steel, Tata Steel and Hindalco in a staggered manner for the long term.

What is your view on markets for 2021?

The equity markets have seen a sharp run-up in recent months, anticipating a strong economic and earnings recovery. Going forward, we would remain cautiously optimistic on the markets in the near term as some profit-taking or consolidation can’t be ruled out. Further, rising bond yields continue to remain the key concern for markets globally. Besides, the pace of economic recovery and earnings’ trajectory would dictate the trend for the markets in the medium term.

Technical Outlook: Commodity Stocks

Since the start of 2020, the corona virus pandemic has overpowered the cyclicality phenomena in the Indian stock markets, where almost all sectors have witnessed similar momentum. There has been a sharp fall till March end 2020 followed by a consistent rise till date. Commodities index was no exception to it, where the index gave a kind of triple bottom pattern in the zone of 2,065-2,085 at the end of March 2020 followed by recovery giving higher tops and higher bottoms. At the end of February 2021, the index breached its all-time high and is now trailing at its peak. Considering the recent data, the index could not sustain 4,540 on daily closing basis and on March 5, 2021 it filled the gap on the downside. The oscillators are tilted southwards with a negative crossover band a negative divergence between price and the oscillators which suggests some correction in the near term. However, long-term data is intact and there is room for some more upside, but on dips.

Metal

Tata Steel: The steel major attempted to breach its multiple resistance at 735-740, but failed to sustain on monthly closing basis during February 2021. The stock has bounced back in March and would continue with the upside momentum once the stock surpasses 740 on a closing basis. A slight near-term correction is due where we hold 720-700 followed by 655 as the support. Fresh buying to start only above the 740 mark.

Hindustan Copper: This copper manufacturer has given a dynamic impulse in February, breaching its prior two multi-year resistances with a spurt in volume. The stock has witnessed slight correction at the start of March which is majorly in the form of a pullback and shall bounce back soon for further upside.

Crude

ONGC: This oil exploration company extended its downbeat up to October 2020 followed by bottom fishing in the recent four months. Considering the daily timeframe, we see an accumulation breakout in the form of a rounding pattern breakout and we foresee a bullish move in weeks to come.

BPCL: This OMC on the other hand has recovered more than 70 per cent of the sharp downside from November 2019 to March 2020 after hitting a double top in November. Now the stock is heading again towards its double top at 550 mark.'

Cement

Ultratech Cement: This cement giant has seen a sharp upside since April 2020 and is posting record closure every month since November 2020. The oscillators are inclined northwards and hence any correction in near term seems blurred. Investors can hold their positions and start selling on rise in case of any visible correction.

Fertiliser

Coromandel International: This fertilizer giant is hovering at its peak since July 2020 and further upside can be seen only above 840-850. Investors holding the stock may note that the stock has strong support.

Technical Outlook: Commodity Stocks by Bhagyashree Sawant, Product Manager- Equity and Ganesh Angaj, Head Technical Analyst, Khandwala Securities Ltd

Conclusion

There are many investors, especially those who have been participating in the markets only since 2018, who find commodities stocks “boring”. Commodity stocks and the Nifty Commodity stocks has been underperforming both the broader markets and the key benchmark indices for so long that one may conclude that the index is a perpetual underperformer. However, the outlook on the commodity stocks has changed and the momentum is clearly in their favour. Agreed that the commodity stocks may not be as interesting and modern as technology stocks or the stocks that benefit from increasing consumption trend across the nation, but commodity stocks or businesses are the ones that drive the global economy. One cannot visualise global economy running smoothly without commodities such as metals, oil and gas, etc. The commodity stocks are cyclical in nature and hence can be difficult for most investors to understand. It is very important to get the timing right when one invests in commodity stocks.

The current economic conditions (improving) and increasing liquidity aided by monetary stimulus worldwide along with rising demand due to recovery across the globe are leading to a bull cycle in commodity prices. With rising commodity prices the biggest beneficiaries are the commodity stocks. Investors can take advantage of such a situation. Experts believe that inflationary conditions augur well for commodity prices. While inflation may not be great for equity prices in general as the bottom-line is negatively impacted due to rising raw material prices, the logic does not apply to commodity stocks. An inflationary environment is positive for the commodity stocks.

As of now, the US bond yields and the bond yields in India indicate that inflation may increase in the coming quarters and that the interest rates may also increase in the foreseeable future. The market is already discounting such a scenario but at the same time is also discounting a huge stimulus of USD 1.9 trillion in the US markets. There is also a possibility that the stimulus once executed will further lead to inflationary environment in the US. So, on one hand the market will take support from the stimulus announcement and on the other hand it may react negatively to the chances of rising inflation due to excess liquidity. While the overall market may remain in a consolidation mode, the commodity stocks are in a sweet spot with rising demand and strengthening commodity prices across the board.

The commodity stocks have been out of fashion for quite some time and do offer some value even after outperforming the markets in recent months. There is clear preference for value stocks from growth stocks globally. Commodity stocks can be seen as value stocks given their long underperformance and the current valuations. A majority of the commodity stocks are looking way cheaper than the overvalued FMCG, IT and pharmaceutical stocks, thus providing a churning opportunity for active portfolio investors. Definitely, there is a strong case for increasing portfolio allocation to the commodity stocks.