Is this still the dawning of the age of ASX commodity shares?

Let's take a closer look at what the market and the experts are saying.

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Key points

  • Commodities have staged a huge rally in the past month that sees most markets soaring to multi-year highs. 
  • The question is if the global rally will transpose with as much force into ASX commodity shares. 
  • As a basket, ASX commodity players are faring well on the back of the rally – but there are some curious exceptions. As always, there are no blanket rules. 

As conflict in Europe takes another unsuspecting turn, the outlook for commodities continues to shine – much to the dismay of consumers in the end-market.

Talks of a ban on Russian oil exports are being taken very seriously amongst market pundits, such that Brent Crude futures nudged past US$130 barrel this week, their highest in more than a decade.

Ukrainian wheat, which is sold on the black sea supply route, has also faltered amid the tension, sending global wheat prices skyrocketing to US$11.40 per bushel after hitting US$12.52/bushel yesterday in response to the disruption.

Nickel futures soared "to infinity" yesterday according to one trader such that the London Metals Exchange (LME) suspended trading of the metal to prevent an all-out disaster. Russia is the world's largest nickel producer.

Gold, the traditional safe-haven asset in times of inflation, spiking interest rates, and geopolitical tension, has also surged to its all-time high and now trades at US$2,055 per troy ounce.

In fact, the Bloomberg Commodities Index (BCOM), a proxy for the performance of a global basket of commodities used by investors worldwide, is at its highest level in over 10 years as well.

It has slowly risen from the depths of 2020, when COVID-19 first reared its ugly head onto the scene. Lockdowns resulted in massive supply shock in both raw materials and commodities, compounded by huge backlogs in supply chains around the world. People had the money, but 'drivers' simply couldn't deliver the goods, due to the lockdowns.

The latest conflict only adds a petrol can to the fire and has sent the global commodity sector into a blaze such that the BCOM has shot up vertically north in February/March.

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Is this the time of ASX commodity shares?

By all accounts, a surge in commodities like gold, nickel, wheat – any product for that matter – is usually a net positive for the producers and miners.

However, miners, explorers, refiners and every player along the value chain realises the impulse effect from a massive jump in the price of base commodities. It's not always a gain though – costs to increase for some unfortunate companies.

Where ASX commodity players realise the biggest benefit is to revenue, operating cash flow and free cash flow.

Each of these stem from gross profit and net profit respectively. The surge in commodity prices helps miners and producers at the margin, by feeding more cash down through the income statement for operations and then after everything has been paid.

If fundamentals are anything to go by, then it's a good chance investors might look favourably on these metrics, particularly as free cash flow, margins and revenue growth are key metrics analysts use to value shares.

Not only that – but bigger profits and free cash flow means the prospect for bigger dividends, something we've seen abundantly clear on the ASX these past 2 years.

However, it's the market's opinion that matters most. Even as nickel surged to unfathomed heights of US$100,000 per tonne yesterday night, shares in BHP Group Ltd (ASX: BHP) – one of the world's largest nickel players – finished in the red today.

Not only that but nickel pig iron specialist Nickel Mines Ltd (AX: NIC) saw its equity value evaporate by over 20% before entering into a trading pause early in the session. It fell 5% by the close of trade today as well.

You see, it's not all that clear at face value. Sure, higher commodity prices mean better revenues for those involved, generally speaking.

But there is a whole other side to that equation, one that involves costs being passed down the line, as BHP recently alluded to.

The mining giant had recently warned of the "spillover effect" from this surge in commodities to things like inflation and global growth.

Moreover, Nickel Mines share price tanked today amid concerns of its ties to Chinese nickel giant Tsingshan and its affiliate Shanghai Decent.

Tsingshan and the affiliate were recently caught out holding an enormous short position on nickel futures which has obviously backfired spectacularly in the last few days. There are reports that coverage of this short position is what may have helped propel nickel so high.

Even though Nickel Mines reassured its deal covenants remain well intact, the market was still weary and offloaded shares with authority today.

What else to consider?

But let's not also forget that this commodities rally, has – according to strategists – been driven in part by a set of extenuating circumstances that most certainly aren't the 'norm'.

The combination of COVID-19 and unprecedented monetary and fiscal policy already staged the perfect storm for the sector to stage a rally. Whereas Russia's invasion of Ukraine and the US Federal Reserve fighting inflation are the two 'sparks' for 2022, according to Bloomberg commodity strategist Mike McGlone.

So much so that McGlone even postulates that crude oil could even trade places with bitcoin as the preferred risk asset of choice for investors going forward.

"When the history of 2022 is written, crude oil at the top of our performance scorecard to Feb. 28 appears at elevated risk of trading places with Bitcoin at the bottom", he said in a recent note.

However, it could be agricultural commodity producers that benefit the most in 2022 according to McGlone, if the current trends keep at pace.

"If prices sustain near end-of-February levels, it should be a boon for energy and agriculture producers", the strategist said.

As the tension continues to garner steam in Europe, it remains to be seen what direction the global commodities basket will head next.

Nonetheless, as a group, ASX commodity shares are outstripping the broader market. Each of the Betashares Australian Resources Sector ETF (ASX: QRE) and the VanEck Australian Resources ETF (ASX: MVR) that track Aussie commodity players are soaring in the past month and have broken away from Australian large caps in the S&P/ASX 200 index (ASX: XJO).

As with any market situation, it appears to be a case of investors separating those companies deemed to produce the highest forward return potential based on a combination of fundamental and market factors.

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Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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