GNR - BCX: Profit From 2023's Commodity Supercycle

Summary

• I assess the opportunities offered by the 2023 commodity supercycle, which some analysts have been talking about.
• In this case, with its mix of energy, mining and agricultural stocks, BlackRock Resources & Commodities Strategy Trust is well-positioned to benefit.
• Taking into consideration the macro backdrop in the first half of next year and China's relaxation of Covid measures, the upside for BCX should only come in H2-2023.

According to analysts at Goldman Sachs ( GS ), there will be a commodity supercycle in 2023, just like in 2022, for reasons on which I will elaborate later.

The objective of this thesis is to assess how investors can benefit from such an opportunity using BlackRock Resources & Commodities Strategy Trust ( BCX ), a closed-end fund ("CEF") which, as shown by the chart below, delivered a 30% upside in 2022.

For this purpose, instead of passively sharing the optimism of the analysts at Goldman, my objective will be to critically assess opportunities, especially in light of heightened recession risks in the U.S. and uncertainty linked with the Covid reopening in China.

First, I provide some insights into commodities and their difference from natural resources by taking the example of BCX's holdings.

BCX's holdings and the Demand-Supply Equation

Whether it is the iron ore mined by Glencore (GLCNF), BCX’s largest holding as a percentage of total assets, or the crude oil extracted by second-place Shell ( SHEL ), these are both extracted from nature and are called natural resources.

Shifting from nature to economics, these resources, whether in the form of commodities or raw materials are then refined or can be used to make a final product like steel or gasoline.

Transitioning from economics to the financial world, commodities like gold, oil, gas, or even cotton are assets that can be traded on financial markets. In this respect, some exchange-traded funds ("ETFs") like the Invesco DB Oil ETF (NYSEARCA: DBO ) hold futures contracts directly and are directly exposed to the movement of commodity prices.

On the other hand, the BlackRock trust invests primarily (at least 80% of its total assets) in equity securities issued by commodity or natural resources companies. It also holds derivatives with exposure to commodities. Thus, it is also subject to the underlying price movement of commodities, determined by the law of supply and demand. In this case, when the demand for commodity increases, at constant supply, its price increases. Conversely, when demand decreases, at constant supply, the price decreases. Thus, it is this delicate balance between supply and demand that determines the price action.

This may all sound so simple when in reality there are so many variables that impact prices as I explained in my recent DBO thesis . For example, some analysts got it wrong on the energy sector which constitutes 36.7% of BCX as per the table below, as even with the Russian supply of natural gas and crude oil being removed from the global energy equation in March of this year, prices failed to move to the $100 level in this quarter as some had predicted .

Instead, demand has been suppressed due to the world’s first importer of oil or China persistently delaying its Covid-related opening as infection rates continued to surge. Going to the other side of the Pacific Ocean, rising economic slowdown risks as a result of the Federal Reserve aggressively tightening monetary policy in the U.S, which was the world’s largest consumer in 2021 also added to demand concerns and caused downward pressure on prices.

On the other hand, the main reasons for Goldman being bullish seem to be from the supply side, namely shortages as well as insufficient investment in additional capacity.

I assess these two factors below.

Assessing the Supercycle Rationale

First, a supply-side problem could emerge in case the oil embargo imposed on Russian crude by European countries and the price cap mechanism which has been enforced for the rest of the world including Asia is successful at curbing production. Also, it will also depend on how the Saudi Arabia-led proposed production cut of two million barrels per day is adhered to by members of OPEC (organization of petroleum exporting countries) and its allies. Now, for investors who doubt the ability of the oil cartel to execute its plan, they will note that it successfully limited production soon after the onset of Covid in order to support prices.

Second, as to investing into capacity, the chart below shows the capital expenses to sales ratio for BCX’s first ten holdings. Now, with the exception of Glencore and Deere ( DE ), and CF Industries ( CF ), all other companies have seen a downtrend in the ratio of capital expenses to sales.

Still, their CAPEX to sales ratios when expressed as a percentage comes out to be roughly 7% on average. Seeking to perform a comparison with the industry, research by Refinitiv shows that the CAPEX to sales ratio for U.S. oil producers for the last 12 months has declined to 17.1%, which is more than 10% behind historical levels.

Therefore, in these circumstances, with supply being removed from the global energy equation due to Russia and OPEC, and production being reduced, it looks more probable for supply to be impacted.

Looking at demand, it should also suffer given that America's economic slowdown concerns I talked about earlier have escalated into recession risks , namely in the second half of 2023. Now, while the exact effects of a recession are difficult to predict, it is normally characterized by slowing demand due to widespread uncertainty about economic growth. Drilling deeper, according to some sources, economists expect a contraction of 0.4% in the first quarter of 2023. While this grim outlook will certainly weigh on stocks, this negative growth is still lower than the figures for past recessions in 2008-2009 or even the Covid freeze of Spring 2020, which means that it will be a mild one.

In these circumstances, investors can expect a downside in BCX's share price, but it will not be like in 2020, especially because of the China factor.

For this purpose, China is the world's second-largest consumer of crude oil and natural gas (2021 figures) and since it does not possess the same level of natural resources as the U.S., it is one of the largest importers. The same applies to other commodities like iron ore, copper, and soybeans, whose prices should get some support while the country comes out of Covid hibernation.

However, the number of infections is rising exponentially with many employees also being infected. This could create a disturbance in Chinese economic activity hampering demand for oil and industrial metals, in turn adversely impacting BCX's stocks operating in the energy and mining sectors respectively as pictured in the sector breakdown above. Still, with renewables consuming 12 times more copper than with convention methods of generating energy. Along the same lines, other industrial metals should also witness more demand.

Pursuing further, with the Ukrainian conflict looking to linger, the U.N-driven agreement with Russia which allows Ukraine's grain export to transit through the Black Sea could face uncertainty, implying higher wheat futures, which bodes well for fertilizer producers Nutrien ( NTR ).

Putting it all Together

Therefore, there may indeed be a commodity supercycle in 2023, but, it will not take the same form as this year because of two main factors which are recession risk in the U.S. and uncertainty as to the effects of a rapid relaxation of Covid measures in China. Thus, contrary to this year, when BCX had already gained about 24% by June, expect the trust to undergo a sustained upside only from the second half of 2023.

This longer-term outlook is also justified by its three-year outperformance of the SPDR S&P 500 Trust ETF ( SPY ) by more than 1% while paying more dividends, as pictured below. This period includes the Covid stock market crash. Also, while the BlackRock trust charges higher fees of 1.07% than the SPDR Index Shares Funds - SPDR S&P Global Natural Resources ETF ( GNR ), it pays a higher dividend yield, and on a monthly basis too. I included GNR in the comparison as it shares many common holdings with BCX.

Adopting a dose of caution, investors should note that commodity prices are extremely volatile as in addition to demand and supply, there so many factors like pipeline and storage that determine short-term market moves. Thus, in addition to the China reopening story, there are also U.S. crude oil reserves dropping more than expected which is driving current optimism. As a result, after a one month upside of 1.26%, expect some downside in BCX as infection-related news from China hits the market. Consequently, it is better to exercise patience and wait for the current volatility episode to end before investing.

Finally, based on the three-year performance of 22%, I have a target of $11.7 (9.57 x 1.22) by 2025 based on the current share price of $9.57. By that time, the Fed would have also shifted to a much more dovish tone.

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