By Ryan O’Malley, Fixed Income Portfolio Strategist
Not all commodities have benefited equally in reflation / reopening trade. Some exhibit structural imbalances between long-term supply and demand, while others have experienced short-term speculative price increases that have proven unsustainable.
Forest products / lumber
This sector benefited from a hyperbolic housing market in late 2020 and early 2021 as many former city dwellers took advantage of the work-from-home revolution and moved to the suburbs; However, after mortgage rates fell in February, the cost of owning a home quickly reached unsustainable levels for many middle-income Americans. The speculative bubble in lumber futures quickly reversed, and lumber prices are now down 65% in the past three months, and below their starting point in 2021, as home sales have cooled significantly.[wce_code id=192]
Aluminum and steel continued to hold their peak prices despite concerns about a global slowdown, indicating that there could be a structural supply / demand imbalance in the long run.
Favorable winds, such as the trillion dollar infrastructure bill, combined with a large backlog of commercial property construction that was stranded during the worst of the Covid-19 crisis, drove the growth in demand for steel and its peers to far exceed the growth in supply. Since the nadir of June 2020, the demand for steel in the United States has increased by about 65%, while the supply has only increased by 44%.
Energy commodities have proven to be even more resilient. Demand has almost reached pre-pandemic levels, but supply remains limited as U.S. shale producers have kept production below 2019 levels and have shown great discipline in their balance sheets. West Texas Intermediate crude oil has hovered around $ 70 / bbl over the past two months, a level not seen since 2018. And natural gas is poised to break through $ 5 / MMBtu, a level not seen since 2014.
Given this dichotomy in commodities, our preferred investment grade credits include Energy Transfer Partners (ETP) and Cenovus (CVECN). Both are expected to benefit from strong and continuing demand as the economy reopens and they use excess liquidity to rebuild their balance sheets.
In the high-yield space, we favor US Steel (X) and Alcoa (AA). Both are major producers of industrial metals and occupy favorable positions in the supply chain to take advantage of the extremely high demand for their products. We also like Occidental Petroleum (OXY), an angel oil producer that takes advantage of the high price environment to sell non-core assets to reduce its leverage to investment grade levels. Finally, we favor Teekay Corp. (TK), a liquefied natural gas (LNG) maritime transport supplier. The company is taking advantage of the voracious demand for LNG from countries in Asia and Latin America that do not have the monstrous supply from the United States.
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