GNR - GNR: Value Momentum And (China) Growth

2023-09-25 04:31:51 ET

Summary

• Investing in real return ETFs is recommended due to expected inflation above the Fed's 2% target in the coming years.
• Global natural resource equities serve as an inflation hedge and benefit from green energy trends.
• The SPDR S&P Global Natural Resources ETF provides international diversification, exposure to Chinese growth, and a cheap valuation.

In our previous article about SPDR SSGA Multi-Asset Real Return ETF ( RLY ) we made the point that investing in real return ETFs remains a good idea as we expect inflation is to stay above 2% the coming years.

The biggest position in RLY is the SPDR S&P Global Natural Resources ETF ( GNR ). RLY's portfolio managers remain positive about both global natural resource equities and infrastructure equities because they "stand to benefit from infrastructure spending along with longer-term trends of de-carbonization and other green energy thematic". While we do not really agree with the infrastructure part, we do agree with their vision on global natural resources equities and the role they will play in the green transition. GNR gives investors also access to the China growth story without a direct investment in the country itself.

Inflation hedge

Natural resource equities offer an investor many advantages: they enhance portfolio diversification, they give access to global growth in general and Chinese growth in particular and they are a good hedge against inflation . Especially in high inflation environments (above 6% inflation) natural resource equities (agriculture, energy, and metals and mining) are performing strongly. But also in milder inflation regimes (between 2 and 6% inflation) the performance is nice.

Research by Northern Trust Asset management also shows that natural resources equities perform well in high inflation periods (when inflation is above 3.2% which corresponds to the 75th percentile of the data). The percent of time the asset class "covers inflation" (that is, provides a positive real return) is highest for commodities and …. natural resources equities.

Historically, miners increase capex and production when metal prices are high. And at a given point supply becomes bigger than demand and prices collapse. This results in a cut in capex and at a given point demand surpasses supply and prices start rising again and the cycle starts over…

Today in the natural resources sector, the focus is more on leverage reduction and returning cash to shareholders and less on capex and growth for the sake of growth. This increased capital discipline from producers limiting excess supply means commodities should find reasonable support. Increased geopolitical tensions (like Russia's invasion in Ukraine) can also lead to higher inflation.

So while supply will be rather low and at the same time demand is rising due to the green transition.

Research by the International Energy Agency (IEA) shows that mineral demand will double under the Stated Policies Scenario (which only takes policies already announced into account). Under the Paris Agreement Scenario (which aims "to limit the temperature increase to 1.5°C above pre-industrial levels.") demand will grow almost fourfold by 2040. In the Net-zero by 2050 Scenario demand would even increase six times.

If inflation is to stay above 2%, global natural resource equities can keep playing their inflation hedging properties.

International diversification

GNR is internationally diversified.

Despite years of underperformance, the case for international diversification remains strong, as we discussed in this previous article .

International diversification offers downside protection, a cheaper valuation and higher dividend yields. And it now scores also good on momentum.

Over the past 12 months the MSCI ACWI index is outperforming the S&P 500….

And while GNR doesn't invest in Chinese companies, it does offer access to the China growth story.

China growth story

China accounts for more than 50% of global consumption of aluminium, copper, and nickel and almost 50% of global consumption of lead, tin and zinc. Growth in China is hence very important for the outlook of those commodities.

Looking at Chinese stocks and their underperformance suggest that growth is disappointing for the moment.

And this is indeed due to China's declining growth trend.

But the Chinese government is taking measures to spur growth. For the second time this year, the People's Bank of China has slashed the reserve requirement ratio ((RRR)) for most banks by 25 basis points, bringing the weighted average RRR down to 7.4%.

But even before this extra loosening of financial conditions, things were already improving in China.

The stimulus already had a positive impact on e.g. copper prices.

And this is of course good news for global natural resources equities.

Valuations

Natural resources equities offer a cheap valuation. Their valuation is more or less half that of equities in general. This is the case for dividend yield, P/E and P/B.

The current P/E for natural resources equities is also attractive compared to its own history (13x).

Research by Northern Trust Asset management showed that Apple ( AAPL ) and Microsoft ( MSFT ) represent a larger percentage of S&P 500 market cap than the entire Materials and Energy sectors combined while the latter contribute far more to the overall S&P 500 earnings.

This was also the case 10 years ago, but then the market cap of Apple and Microsoft was much lower than the entire Materials and Energy sectors combined. The current situation is of course explained by the higher expected earnings growth of the tech duo. But wasn't this also the case ten years ago?

A nice combination of value and momentum: GNR isn't only cheap, it's also in a long term uptrend.

Conclusion

Global natural resource equities are not only a good inflation hedge but also a hedge against increasing geopolitical tensions. They provide also diversification for US equities in general and concentrated technology holdings in particular.

Despite years of underperformance, the case for international diversification remains strong. International diversification offers downside protection, a cheaper valuation and higher dividend yields. The SPDR S&P Global Natural Resources ETF offers exactly the same benefits and on top of that it offers exposure to real possibility that Chinese growth surprises to the upside.

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