At the beginning of this month, I highlighted Marc Faber's warning that all industrial commodities are vulnerable to a slowdown in China's property market. That process now looks to be well underway: Industrial commodities suffered across the board in May as investors focused on the Chinese government's efforts to prevent their economy from overheating (not to mention Europe, which will almost certainly act as a drag on global growth over the next several years). Oil and copper were off their highs by more than 20% this month.
Not to worry: Stock investors can still hedge some of the macro risks in the current "minefield" environment, and they could earn solid returns in the process.
The inflation/deflation see-saw
Deflation is the biggest near-term risk in the U.S. and other developed economies. But in the long run, inflation (or hyperinflation) could pose a greater danger, as governments fight the temptation to pay back the huge sums they've borrowed by printing more money.
That dichotomy presents a genuine conundrum for investors who wish to hedge their inflation risk via commodities, but are wary of doing so in the face of falling commodity prices and raised uncertainty about the strength of the economic recovery. The United States Oil Fund
A major improvement over commodities
One solution that looks attractive involves gaining exposure to commodities through the shares of resource companies. In particular, several European oil majors are trading at historically low multiples and offer substantial dividend returns:
|
Company |
Forward P/E Multiple* |
Dividend Yield |
|---|---|---|
|
Total |
6.0 |
6.5% |
|
Repsol |
6.5 |
4.7% |
|
BP |
5.5 |
7.7% |
Source: Capital IQ, a division of Standard & Poor's, Yahoo! Finance.
*Intraday May 24, 2010, based on calendar year 2011 estimated earnings-per-share.
Commodity exposure with a margin of safety
BP, of course, has been tarred by the oil slick in the Gulf of Mexico, and all three companies have been caught in the downdraft resulting from the European debt crisis (especially Repsol, which is based in Spain). Still, the companies' long-term earnings power doesn't seem impaired, and current valuations appear to offer a margin of safety regarding that risk. To those three names, I would add Royal Dutch Shell
China isn't the only economy experiencing booming demand for commodities and infrastructure: Tim Hanson describes the biggest investment opportunity this year.
