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Oil vs mining: Which is the better commodities investment?

29 June 2022

Commodities have thrived in recent months but with such a broad array of assets within it, investors may ask whether oil or mining stocks are the better option.

By Tom Aylott,

Reporter, Trustnet

Pent up demand from clogged up supply chains and a drastic market rotation have acted as a booster to the performance of commodities assets.

While darling sectors have struggled as investors have shifted away from the growth style that carried much of the market for the past decade, funds in the IA Commodities and Natural Resources sector have thrived.

It has a 17.7 percentage point lead on the MSCI World, having increased 7.9% since the start of the year as inflation has bolstered mineral and oil prices.

Total return of sector vs index

Source: FE Analytics

Although returns have steadily climbed, Andy Merricks, fund manager at 8AM Global, pointed out that the commodities sector is very broad and that within it there are assets ranging from precious metals and industrial metals to oil and gas, with renewables and agriculture thrown in as well.

“It covers such a wide area nowadays with the advent of ETFs [exchange-traded funds] and more specialist funds. It’s a bit like putting equities into one pile,” he said.

The question on the mind of investors looking to profit from the commodities rally may be, ‘which of these assets is outperforming the most?’

Neil Veitch, global & UK investment director at SVM Asset Management, said that he sees better opportunity in oil stocks, which have historically been less favourable than mining assets due to their increased volatility and reliance on one commodity.

He said that many mining companies have to navigate regulatory, financial, and environmental hurdles before building a new site is possible and that overcoming these obstacles is often a very time consuming process, meaning that supply needs can be disrupted whilst companies wait for the green light.

Oil operations, on the other hand, can be set up far more swiftly, according to Veitch. He said: “These barriers to entry limit the potential for new supply to disrupt pricing and benefit those companies with existing production. Oil & gas projects, by contrast, can typically be brought onstream much more quickly meaning any period of higher prices is met by a swift increase in supply.”

These are also located in more stable regions than mining sites a lot of the time, Veitch added, such as in the North Sea or in the US, which alleviates the threat of political interference. This can be a massive benefit for oil companies, which will not have production delayed by sudden and drastic policy changes.

Likewise, many oil projects are based at sea, which further reduces the risk of external intervention, according to Veitch.

At present, the sector has benefited from sanctions towards Russia, with many countries banning the import of Russian oil and gas followings it invasion of Ukraine. This has led to a limited supply of oil and a huge gap in demand to fill.

As a result, companies such as Shell have announced some of their highest profits on record as the price for a barrel of oil has jumped to $120 (£94.90).

Windfall taxes placed on these companies to spread the cost increases on consumers will likely dampen these huge inflows, but oil remains in very high demand.

Mark Hume, co-manager of the BlackRock Energy and Resources Income trust, agreed that the oil sector was in a strong position.

“We believe the traditional oil and gas sector has entered a new era, one characterised by better capital allocation and increasing returns to shareholders,” he said.

However, he noted that investors should not discount the mining sector either, with minerals used across a wide array of production lines, making those types of assets highly sought after.

Mining assets will most notably play “a vital role” in the world’s transition to clean energy, he said, with more than 190 countries signing up to the Paris Agreement, which commits them to reaching net-zero carbon emissions by 2050. In achieving this, a great number of materials will be needed to build the necessary infrastructure.

Hume said: “Mining companies provide everything from materials to build wind turbines to lithium for electric cars, while traditional energy companies are still important to heat our homes and drive economic development.

“This flexibility has been beneficial in performance terms more recently, with commodity prices having risen significantly.”

If mining assets continue to perform as well as they have, the sector will soon enter an “era of the shareholder” characterised by stringent capital allocation, according to Hume.

Investors could expect higher returns and lager pay-outs from their holdings in mining equities in this scenario.

“Mining companies in particular remain in an extremely strong financial position, focused on capital discipline and shareholder returns. They have strong balance sheets compared to other sectors, as well as an attractive dividend yield relative to broader equity markets,” he said.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.