Metals, minerals and chemicals – where are the opportunities?

The materials sector encompasses businesses involved in the mining and production of a range of metals, minerals, and chemicals.

Traditional metal miners will likely be the first to come to mind, producing gold, copper, iron, and steel. Some of the largest businesses in the sector are chemical producers, think fertilizers, and industrial chemicals. There are also businesses involved in construction materials like cement, glass, and gravel, as well as wood-based products like paper packaging and lumber.

The sector is also traditionally cyclical. That means demand for products tends to ebb and flow along with the health of broader economic conditions.

So, how has the sector performed?

Over a five-year time horizon, the sector has outperformed the broader market.

A significant contributing factor was the post-pandemic boom in economic activity. As economies worldwide reopened, higher demand for materials like iron ore, copper, and nickel pushed prices higher. For some miners, that meant record profits and bumper shareholder returns over 2021/22.

Total return

Past performance is not a guide to future returns. Source: Refinitiv Eikon, 06/04/2023 (materials sector represented by the Refinitiv UK Basic Materials Index).

The past 12 months have seen a reversal of fortunes to some degree, with the sector down 9.8% compared to a 1.8% rise for the broader UK market (as of 06/04/2023). This is a perfect example of the sector's cyclical nature. Higher inflation, the war in Ukraine, and repeated lockdowns in China weighed on the outlook for global economic growth.

Looking ahead, China has reopened which should be positive for global growth. However, the recession risk in 2023 is very real across a number of major global economies which has the potential to drag on demand for basic materials.

But while cycles come and go, we like to focus on longer-term demand drivers and see pockets of opportunity within the sector.

Energy transition presents an opportunity

The energy crisis seen over 2022 and a global push toward net-zero by 2050 both support the same message – a need to decarbonize, lower costs, and boost resilience.

Reaching those targets means rethinking how we live and work, while improving technologies to enable that. That means a shift in the demand dynamics for a host of metals needed to expand renewable energy sources, evolving battery technology, and build green infrastructure.

There's an opportunity for a host of companies in the materials sector. Take the shift to electric vehicles as an example.

Critical minerals needed for engine production (kg/vehicle)

Source: IEA 2022.

Electric engines need more copper and manganese than their combustion counterparts, plus other materials like lithium and nickel – which presents an opportunity for metal miners.

Take copper. Its use dates back to Ancient Egyptian times, where it was used to disinfect wounds and even further back than that, as material to craft weapons from. Modern uses take full advantage of its heat and electrical conductivity, from electric vehicle engines to power storage and household wiring.

Supply's expected to reach around 300 megatons by 2030, but global economies are projected to demand an additional 50 megatons.

The mining industry has been wary of making large multi-billion dollar investments to bring new sites online. As inflation lingers and costs rise, large-scale greenfield projects could be even more unlikely. Some industry giants estimate investment in expanding copper supply in 2025 will be 61% below the 2012 peak.

Lithium is another benefactor of the energy transition, with demand expected to increase nearly five times by 2030 from levels seen in 2021. Prices have tumbled from the record highs seen in November 2022 due to a combination of lower demand in China and an unexpected increase in supply. But we remain supportive of the longer-term outlook.

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Lack of exploration

As demand for materials increases, we need to dig more stuff out of the ground. There are two ways to increase supply, increase output at existing mines or discover new deposits and build new mines. The latter of which is the key to meaningful global output increases.

The prices of metals and the availability and cost of financing, heavily influence exploration. Recession fears, cost inflation, and higher interest rates mean prices have gone down and finance costs have gone up – a recipe for conservatism around embarking on new and expensive projects.

We're starting from a lower starting point too. The last time metal prices performed as well as they did from mid-2020 through the end of 2021 was back in 2011-12. Exploration budgets in 2012 were almost two thirds higher than in 2022. So, not only are conditions unsupportive of exploration, we're nowhere near previous peaks.

This lack of exploration spend feeds into the general consensus that there'll be a scarcity of supply across large parts of the materials sector in the medium term. That presents opportunities for miners with existing operations or fresh powder to snap up smaller projects.

Gold’s time to shine?

Gold is often viewed as a unique asset because its price movements aren’t highly correlated with other investments like stocks and bonds. This means that gold can potentially provide some shelter for investors when markets wobble.

We've seen these qualities play out in recent years, with the price shooting higher as the pandemic hit and investors looked to assets they perceived as being able to hold value.

In February, we saw some more promising US economic data which saw gold give up most of its year-to-date gains. But we still see several potential tailwinds over 2023, from geopolitical uncertainty to economic slowdowns across many developed markets.

We think it’s a good idea to hold some gold as a small part of a diversified portfolio. But we'd caution on relying too heavily on the asset offering shelter from higher inflation, as is often discussed as a potential property of gold. That might be true in the long run, but the results are less convincing over shorter periods.

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Our view

We see several short-term challenges that are likely to impact sector profits, mainly commodity prices coming under pressure due to slowing global growth.

We think certain pockets within the sector could do well on a longer-term perspective – especially those exposed to future-facing materials with strong balance sheets to help weather any short-term storms.

This article isn’t personal advice. If you’re not sure if an investment is right for you seek advice. Investments can fall as well as rise in value so you could get back less than you invest.