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OPINION

Back from the brink

Back from the brink
October 9, 2015
Back from the brink

The culprit is, of course, the London market's massive exposure to commodities, whose prices have continued to weaken this year. And it is partly a minor revival of raw material prices in the last week or so that has brought about the boost. Nowhere will the slightly brighter pricing outlook be more welcome than at Glencore, the embattled commodities producer and trader – after plunging 75 per cent since May its shares have almost doubled in the past week.

Does this, then, mark the commodity sectors’ nadir? Possibly – but I would be hesitant to cheer the end of the commodity slump just yet. It is still largely unclear what direction China’s economy will take, either – it is still guiding towards 7 per cent GDP growth, but few people believe this represents the true picture. Without Chinese demand commodity prices will remain subdued. What’s more, a more stable pricing environment will require significant reduction in supply – large producers will be more easily able to absorb this than smaller ones, who could find themselves forced out of business. It’s a sector that could revert to the large volume, low margin business of old, with the excitement of the commodities exploration boom almost certainly over; instead the focus will fall upon companies with producing assets that can turn these into dividend streams.

It’s also very clear that falling commodity prices have been significantly responsible for the very weak inflation reading seen in many countries – a boost for some companies but not for others, not least the grocery sector. Tesco’s profits were halved in the first half as a result of the ongoing price erosion, caused partly by cut-throat competition but also because agriculture commodity prices have been weak. Just as with hard commodities, many softs have been in market surplus, but the most severe El Nino for years could again tip markets into deficit.

Whilst I do not expect runaway inflation any time soon, issues like these are one reason why I’m less convinced that the deflationary price environment will continue indefinitely. Supply tightening means the dampening effect of lower oil prices will wash out of inflation calculations, while wage growth is on the up, too – that’s a potentially good mix for supermarkets, for whom it’s often been said that a little inflation is a good thing. Their shares have also bounced this week, not because things are about to get immediately better but because they may not now get much worse. It’s hardly the most compelling case for buying their shares, but like miners, a switch to a less expansive, less capital-hungry state of mind – back, in fact, to being the boring businesses they once were - should eventually improve cash returns to shareholders.