Despite the recent rally in commodity prices, I believe investing in the Footsie’s drillers and diggers remains extremely risky business.
Market appetite for oil colossus BP (LSE: BP) and copper giant Antofagasta (LSE: ANTO) has exploded in recent weeks, the stocks advancing 26% and 22% during the third quarter.
Investor sentiment has been buoyed by Brent crude hurtling back, the black commodity this week striding back above $52 per barrel to reach its loftiest since June. And bellwether metal copper has touched $4,850 per tonne in recent sessions to hit its own multi-week peaks.
On the plus side…
But a recent rise in commodity prices isn’t the whole story, of course. Indeed, stock pickers have been enticed by the fact raw materials plays like Antofagasta and BP source almost all of their earnings from abroad, mitigating the negative impact of Brexit on their investment portfolios.
On top of this, demand for the companies is also benefitting from steady sterling depreciation as their earnings are reported in US dollars. Just today the UK currency fell to fresh 31-lows below $1.27.
However, this isn’t to say that the earnings outlook for either BP or Antofagasta appears to be plain sailing in the years ahead. Indeed, the hulking imbalances washing across all major commodity markets make me worried that the sector’s major players could be in for tough times.
… but still plenty of negatives
Optimism surrounding the oil sector has swelled in recent weeks after OPEC members agreed to a conditional deal that will see the export bloc curtail aggregate production to around 32.5m-33m barrels per day.
However, a formal accord remains far from a done deal, as individual country quotas are yet to be formally agreed to. Besides, a steady increase in output from the US and Russia threatens to undo much of OPEC’s hard work by keeping global inventories at full-to-bursting.
And for copper, sustained price strength can’t be considered a given as the jury remains out on Chinese demand ahead. The raw materials glutton is responsible for the lion’s share of global consumption, meaning that a combination of bulky red metal imports and still-ropey factory floor data could see copper values slide again.
Caixin manufacturing PMI data for September came in on the expansionary/contractionary precipice, at 50.1. This followed news that exports from China have continued to slide, with outbound shipments in August slipping 2.8% in dollar terms, according to latest data.
Recent price strength leaves Antofagasta dealing on a forward P/E rating of 36.2 times, shooting well above the FTSE 100Â average of 15 times. And BP’s prospective figure of 37.5 times is even worse.
I reckon these elevated valuations are greatly at odds with the poor state of the crude and copper markets, leaving both firms under threat of a painful correction.