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A few months ago, I downgraded the SPDR S&P North American Natural Resources ETF (NYSEARCA:NANR) to a hold, following the March regional bank crisis. At the time, I was concerned that the U.S. economy was headed for a recession and thus turned cautious on cyclical exposure.
Since my downgrade, the U.S. economy actually bounced back strongly in the summer, registering a blistering 4.9% annual GDP growth rate in the third quarter, proving many doubters like myself dead wrong (Figure 1).
Figure 1 – U.S. GDP growth registered 4.9% annual rate in Q3/23 (BLS)
To be upfront, nobody has a crystal ball with respect to economic forecasting and investing; it is all about reading the tea leaves and adjusting one’s portfolio to best position for the current situation. I certainly make my fair share mistakes, and I will continue to make them in the future. It is simply part of the investment process.
However, despite a strong rebound in economic activity, the NANR ETF has delivered negative total returns since May, underperforming the markets (Figure 2). This performance partly justifies my caution regarding the fund.
Figure 2 – NANR has delivered negative returns since May (Seeking Alpha)
Looking forward, as we head into year-end and with a Middle-East conflict putting upwards pressure on oil prices, should we continue to be cautious on resource stocks and the NANR ETF in particular?
Brief Fund Overview
For those not familiar with the NANR ETF, the SPDR S&P North American Natural Resources ETF provides exposure to U.S. and Canadian large- and mid -cap natural resource companies in sectors such as energy, metals & mining, and agriculture. The NANR ETF resets its sector weights to 45% energy, 35% metals & mining, and 20% agriculture every quarter.
Readers should refer to my initiation article if they want to find out more about the NANR ETF’s strategy and holdings.
2023 Has Been Tough For Resource Companies
Whereas most commodities rallied in 2021/2022 due to soaring inflation, 2023 has been a tough year so far for resource companies as the underlying commodities have either been range-bound like crude oil and copper, or have suffered sharp declines like corn and agricultural commodities (Figure 2).
Figure 3 – Most major commodities have been flat to down in 2023 (Seeking Alpha)
As a reminder, commodity producers are generally price-takers; i.e. their revenues and earnings are driven by the cyclical nature of the underlying commodity prices and any individual company, no matter its size, generally has little influence on the commodity price by itself.
Therefore, it was not surprising to see revenues and earnings growth of resource companies stalling, and in many cases, even declining in the past year as commodity prices have been flat to down. For example, Exxon Mobil (XOM), the largest energy company in the U.S., reported YTD Q3/2023 earnings of $28.4 billion, a 34% YoY decline from the same period in 2022 (Figure 4).
Figure 4 – XOM earnings declined 34% YoY (XOM Q3 press release)
Similarly, Freeport McMoRan (FCX), the largest copper miner listed in the U.S., suffered an 47% YoY declines in its YTD Q3/2023 net income (Figure 4).
Figure 5 – FCX earnings declined 47% YoY (FCX Q3 press release)
Nutrien (NTR), one of the largest global producers of potash and other agricultural commodities, suffered an even steeper 83% YoY decline in YTD Q3/2023 net earnings, as potash prices tracked corn prices steeply lower (Figure 6).
Figure 6 – NTR earnings declined 83% YoY (NTR Q3 press release)
All three companies, XOM, FCX, NTR, are large weights in the NANR ETF.
Weak Global Economy Offset Blistering U.S. GDP Growth
Speaking of commodity prices, why were they weak given the blistering GDP growth in the U.S., mentioned earlier in the article?
The problem for commodities is that prices are generally dictated by global supply and demand, with minor adjustments for regional differences. So even if the U.S. economy grew strongly, if the rest of the world has weak GDP growth, commodity prices can still be weak.
China, long the engine of the global economy and commodity consumption (China often consumes 50% or more of global supply of individual commodities), has been experiencing weaker than expected GDP growth in 2023. So far this year, China’s GDP growth rate has been a pedestrian ~5%, much lower than the 6-8% that the world had been accustomed to (Figure 7).
Figure 7 – China GDP growth (Trading Economics)
Furthermore, with a struggling real estate sector, China’s demand for commodities like copper and iron ore is much weaker than many investors had initially expected, at the beginning of the year.
If Commodities Acted This Poorly In A Booming Economy…
Looking forward, I continue to be concerned with the global economy, as the Eurozone appears to be mired in stagflation while China continues to struggle with a deflating real estate bubble. Even in the U.S., forward economic estimates call for slower growth, as the effects of higher interest rates start to flow through.
The Atlanta Fed’s GDPNow tool is calling for U.S. GDP growth of only 1.2%, a sharp decline from Q3’s 4.9% pace (Figure 8).
Figure 8 – Atlanta Fed GDPNow tool calling for weaker Q4/23 growth (Atlanta Fed)
The Atlanta Fed’s tool is directionally very accurate and called the positive surprise in Q3 as early as August when it spiked to over 5% (Figure 9). So there is reason to be concerned about slowing U.S. GDP growth.
Figure 9 – GDPNow correctly called a positive surprise in Q3 GDP in August (Atlanta Fed)
If commodity prices acted this poorly when U.S. economic growth were generally robust, what will happen if/when the U.S. economy joins the world and slows down?
As I wrote in my prior article, commodities tend to plunge during recessions since commodity supply tends to be inelastic. When consumers and businesses reduce demand, commodity prices can collapse, as shown by the behavior of WTI crude oil prices around recessions (Figure 10).
Figure 10 – Crude oil prices plunge during recessions (Author created with data from St. Louis Fed)
Upside Risks From Geopolitics
On the upside, there are rising geopolitical risks to commodity prices that could benefit resource producers. Specifically, if the recent Israel/Hamas war becomes a regional conflict, then obviously oil prices will spike higher, which could benefit energy producers in the short-term.
Furthermore, Israel is a large exporter of potash, so continued conflict in Israel could disrupt potash exports and benefit producers in other countries like Canada and South America.
However, historically, geopolitically driven commodity price spikes tend to be short-lived. If the spikes are severe enough, resource equities may even price in a resulting recession and skip over the near-term boost to revenues and earnings.
Conclusion
Since my downgrade of the NANR ETF in May, resource equities have struggled, with many companies facing headwinds from stagnant prices and rising costs, crimping profits.
Despite robust U.S. growth, commodity prices have been flat to down as global growth has been weak. If/when the U.S. joins the rest of the world in a slowdown, there is significant downside risks to commodity prices and resource equities. I remain cautious on the NANR ETF and continue to rate it a hold.