Since the end of April, Equities have derated by 10-15% whereas the respective Commodities have only corrected by 3-5% – what gives? Equities are forward looking instruments that discount future earnings and cash flows, whereas the underlying Commodity markets are dictated by physical market trends seen by the shape of its curve; either you have it or you don’t! Right now, the fear factor in the equity market seems to be at extremes.
2012 started the year with positive global economic surprises across the board coupled with the excess liquidity being pumped by global central banks that caused a massive rally in all risk assets. Currently the data is going through a soft patch providing mixed signals that caused profit taking. US GDP growth seems to have stalled a bit, albeit still supportive averaging 2-2.2% annualised in q2’12 and q3’12. EU slowdown has already been priced in. No one is talking China? Looking at the macro economic data from China, suggests a pick up is taking place. The physical commodity markets indicate the same tightness showing a deficit in select markets like oil and copper. Aluminium is trading at marginal cost of production, surely the downside is limited?
So if the Commodity prices are following fundamentals, is it not fair to say the respective equities are oversold especially if their earnings are driven by these very same commodity prices, why should the p/e’s be compressed? It’s the same phenomenon we saw last year at the peak of the Eurozone crisis, when unwinds caused massive fundamental dislocations across the board. Currently cash levels are high, and people are uninvested. Most refuse to trade as just not sure how to survive in these markets. Volumes are dire. Seems to me the pain trade is up from here?
One does not need to ride up the risk curve at all to find good value and compelling risk/reward investment opportunities. Large cap oil and mining stocks are trading close to a 4-6% free cash flow yield with solid balance sheets and visible growth going forward. Would you rather have your money earn 0% in savings, < 2% in the bonds, or see it devalue each day?
