Low equity valuations have enabled these exceptionally high dividend yields. For the period ending June 2023, natural resource equities traded at 10 times trailing 12-month earnings, versus 24 times for the S&P 500. Even accounting for inherent cyclicality, natural resources trade at 11 times their long-term trend earnings, versus 26 times for the S&P 500. This level has been in the bottom fifth percentile for the last 50 years, reflecting historically cheap valuations that do not match the more shareholder-friendly behavior exhibited. Those buybacks and dividends, along with the risk reduction from cleaner balance sheets, have so far allowed the sector to be much more resilient during this cyclical downturn than it has been in the past. While crude oil is down 31% for the 12 months ending June 30, for example, the S&P 500 Exploration & Production Index is up 11%.
Commodities: Improving collateral returns and roll yield
Despite the usual cyclical volatility in commodity spot prices, the asset class as a whole has seen a similar improvement in underlying return drivers over the past year. Commodity futures have three sources of return: 1) changes in spot prices, 2) collateral returns (typically the yield on US Treasury bills), and 3) roll yield (cost of carry). While spot prices receive all the headlines, it is the other two return sources that enable the asset class to compound over time.
Because short-term US Treasuries are used for collateral in futures contracts, commodities is one of the few asset classes that directly benefits from higher interest rates. During the last decade, an era of historically low (near-zero) rates, commodities earned a compound return of just 0.6% from collateral. Thanks to recent rate hikes, however, commodities are now earning 5.5% in collateral returns alone.
Roll yields were also unusually negative during the last decade, driven in part by high inventories that pressured near-term spot prices relative to future prices. Today, despite the cyclical weakness in demand, oil, gas, and metals inventories remain at or below historical averages. Producers’ capital discipline has helped, as have higher interest rates, which disincentivize inventory stockpiling. As a result, commodity roll yields have been positive since mid-2021 and contributed 3% to the Bloomberg Commodity Index over the 12-month period ending 30 June 2023.
As the dark blue line in Figure 2 shows, the 12-month contribution to the Bloomberg Commodity Index total return from collateral return and roll yield remains near its highest level since 2001. Meanwhile, the light blue line shows the cyclical weakness in commodity spot prices, which have fallen significantly to the lowest level in eight years. Improvements in collateral return and roll yield have helped cushion investors during this recent downturn, highlighting the opportunity for the asset class to again offer positive compounded total returns, even in a modest commodity spot-price environment.
Monthly Market Review — August 2024
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Brett Hinds
Jameson Dunn