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Why The Buffett Factor And Tightening Financing Are Bullish For Commodities

Published 09/14/2020, 11:01 AM
Updated 07/09/2023, 06:31 AM

This article was written exclusively for Investing.com

  • Buffett buys natural gas infrastructure, gold production
  • This time an acquisition in Japanese trading companies
  • Buffett gets bullish on inflation, shifts his portfolio to raw material investments
  • Banks retreat from commodity financing
  • Commodities bull market on the horizon

The Dollar Index has been falling since March. The Fed and central banks worldwide are currently committed to pouring a never-ending level of liquidity into the global financial system. Governments are increasing deficits with stimulus programs in order to combat the economic devastation brought on by COVID-19.

The US Fed has said it is willing to tolerate inflation levels above the 2% target rate. The landscape for commodity prices has not been this bullish in decades.

Warren Buffett was uncharacteristically quiet as the global pandemic spread around the globe earlier this year. Instead of picking up bargains, his holding company, Berkshire Hathaway (NYSE:BRKa) sold airline and banking shares. However, over the past months, the Oracle of Omaha began accumulating inflation-sensitive assets as the investing legend turned 90 years old.

He acquired energy assets, precious metals, and Asian trading companies. At the same time, many financial institutions that traditionally financed commodity projects retreated from the business.

While markets rarely move in a straight line and commodities are among the most volatile asset classes, all signs point to higher raw material prices over the coming months and years. The Buffett factor is just one more reason the asset class looks more than attractive as we move towards the end of 2020, a very challenging year for the world.

Buffett buys natural gas infrastructure, gold production

After selling airlines and banks, the first news to come out of Omaha was Berkshire Hathaway’s acquisition of the natural gas transmission and pipeline assets from Dominion Energy (NYSE:D). The deal involved $4 billion in base and the assumption of around $6 billion in debt.

Buffett’s Berkshire will now carry 18% of all interstate natural gas transmission, up from 8%. The announcement at the start of July came right after natural gas fell to its lowest price since 1995.

Source: CQG

As the chart shows, the decline to a low of $1.432 per MMBtu in late June marked a quarter-of-a-century low for the energy commodity. Mr. Buffett scooped up a bargain in the natural gas market.

The next announcement in mid-August involved the purchase of over a half-billion-dollar worth of shares in one of the world’s leading gold mining companies, Barrick (NYSE:GOLD). Barrick has gold and copper mining properties in thirteen countries worldwide.

Gold has been in a bull market, receiving support from a falling dollar, the tidal wave of central bank liquidity causing low interest rates, and government stimulus lifting deficits. All foreign currencies have declined to record lows against gold over the past months.

Buffett began accumulating energy and metals assets and only then announced his next commodity-related acquisition.

This time an acquisition in Japanese trading companies

In late August, to celebrate his ninetieth birthday, Warren Buffett told the world that his company had taken stakes in Japan’s top five trading companies. The investment of over $6 billion bought 5% interest in Itochu Corp. (T:8001), Marubeni Corp. (T:8002), Mitsubishi Corp. (T:8058), Mitsui & Co. (T:8031), and Sumitomo Corp. (T:8053).

Berkshire had been accumulating these positions over the past year. The Japanese trading companies are significant players in the global raw materials markets, expanding Berkshire’s exposure to the commodities asset class.

Buffett gets bullish on inflation, shifts his portfolio to raw material investments

Aside from the declining dollar and flood of liquidity and stimulus, the US Federal Reserve recently told markets that they are prepared to tolerate inflation levels above their 2% target rate. The level that was once a line in the sand has become an average, with voting members of the central bank saying that since inflation has been below the target rate for so long, they would be comfortable with a rise to 2.5% before taking any tightening action.

Since the late 1970s, the landscape for rising inflationary pressures has not been as prevalent.

Moreover, the price action in the commodities asset class from 2008 through 2011 likely influenced Mr. Buffett’s recent acquisitions. Commodity prices rose to multi-year or all-time highs in the aftermath of the 2008 global financial crisis, fueled by the flood of liquidity.

In 2020, the flood has become a tsunami. From June through September 2008, the US Treasury borrowed a record $530 billion to fund the stimulus. In May 2020, it borrowed $3 trillion.

Banks retreat from commodity financing

In an environment that is highly supportive of inflation and rising commodity prices, many financial institutions that were substantial financiers of commodity production and projects are withdrawing from the business.

Over the past weeks, ABN AMRO Group NV (AS:ABNd) and BNP Paribas (OTC:BNPQY) announced that they are retreating from the commodity finance business. A series of scandals and rising costs because of increased regulation are causing many financial institutions to exit as well.

The costs of financing trades and production will increase, putting upward pressure on output costs and market prices. Some smaller producers and traders will find financing impossible, which could weigh on supplies. The developments in commodity finance are likely to add fuel to an already bullish landscape for commodity prices.

Commodities bull market on the horizon

The prices of many commodities have moved higher in 2020. Since the March risk-off lows, crude oil rose from negative territory in the US to over $40 per barrel, before its most recent retreat last week. Copper appreciated from just over $2 to over $3 per pound. The price of silver more than doubled in value since the March low. Gold rose to a new all-time high at over $2000 per ounce in dollar terms. Since mid-August, grain prices have been moving higher. Natural gas rose from a twenty-five-year low to the highest price in 2020 recently, after the Oracle of Omaha announced his investment.

We could be on the verge of a rally in commodity markets that surpasses the price levels seen in 2011. Gold has already achieved that feat. Mr. Buffett’s latest investments are another sign that commodities are the place to be over the coming months and years.

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