How Commodity Capex Depression Will Lead to a New Bull Market
After two extraordinary years of double-digit returns in 2021 and 2022, commodities contracted and underperformed every major asset class in 2023.
How will commodity stocks perform in 2024? Callum Thomas, Head of Research and Founder at Topdowncharts noted that the post-2000's commodity supercycle capital expenditures (capex) depression would most likely result in a higher floor for commodity prices, potentially signaling the commencement of a fresh cyclical bull market for commodity stocks.
How long and how deep the commodity capex depression was
Worldwide commodity producers have exhibited only modest increases in capex over the past decade, with capex-to-assets ratio across all key commodity sectors still trailing historical averages.
This has been particularly evident during the period from 2016 to 2023, which saw significant underinvestment, partially resulting from the 2015/16 commodity downturn and a broader bear market running from 2011 to 2020.
Decade-long bear market in commodities (2011 -2020)
Other factors like the rise of ESG investing curtailing the flow of funds to commodity producers, and the rise-and-rise of tech funneling funds to other opportunities, no doubt also contributed.
Why capex depression = new bull market
Outsized investment returns come when two things happen – the initial price paid (in terms of valuation) for a company is relatively low, and that company experiences a period of improving returns on the capital it invests.
The overall level of capital expenditures in any given sector gives clues as to the future returns in that sector, as both overcapitalized and undercapitalized sectors inevitably revert to the mean.
High returns attract more capital, which effectively compete down returns as even marginal projects move forward. Eventually capital goes elsewhere, and that capital starvation creates a period of elevated returns as only the best ideas/projects get funded.
The inflection points noted below, coming every decade or so, investors have been extremely well compensated for shifting portfolio allocations away from where companies are spending record levels of capex, increasing exposure to sectors where even the companies themselves are choosing to invest less.
Where to from here for commodities?
A lot of the conditions that prevailed in early-2022 which made the bear case clear and compelling have now either switched to outright bullish or simply run their course," said Thomas.
Analysts at Marathon Resource Advisors argued that an extended window of higher company-level returns for natural resource equities has been ushered in driven by severe underinvestment in new projects, accentuated by ESG mandates and viewed with total complacency by an investing public that believes the politicians when they say the energy transition away from fossil fuels will be both cheap and easy.
Conversely, the surging capital flowing to technology and related companies will inevitably lead to lower returns on their investments, which may prove problematic given their generally lofty valuations. Stagnating earnings at several bellwethers are an indication this is already manifesting itself, and they expected that to continue over the coming years.
Source:Topdowncharts, Marathon Resource Advisors
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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AcLongway : great information tells us just how much will be relied on a a stock sector read for great returns and capital gail despite the decade of dissatisfied numbers ñ only will the projects deemed reliable ready to scale n be profitable for bulls
itsgoodinmysoul : Funny enough sounds very logical though caveat is I think I have heard this argument a number of times in past years