Mining and energy stocks in the AFIC portfolio have performed well as macro-economic events weigh upon global equity markets. Inflation, the prospect of higher interest rates, and the war in Ukraine are restraining stock prices generally, but mining and energy stocks have surged.

At our recent shareholder meeting in March, we received a number of questions from shareholders in relation to energy and resources stocks and our investment approach in the current economic environment.

To date in 2022, the S&P/ASX200 index has been extremely volatile. Inflation, constrained supply chains, higher wages costs in some industries, potential interest rate hikes and the war in Ukraine have made the short-term earnings outlook for some companies less certain. Accordingly, investors want to pay lower prices to reflect these heightened risks.

At a sector level, there has been a significant rotation away from previous winners in information technology, consumer discretionary and healthcare into energy, utilities and materials/resources. AFIC’s portfolio includes mining and energy heavyweights BHP, Rio Tinto, Woodside, and Santos.

Energy and resources stocks have rebounded sharply

The energy and resources sectors have rebounded sharply so far in calendar year 2022. Given that Russia is a meaningful producer of commodities, the war in Ukraine has sparked fears of supply constraints of oil, gas, coal and aluminium which has driven up commodity prices. Consequently, the share prices of BHP, Rio Tinto, Woodside and Santos have rallied strongly in recent months.

Woodside is also benefiting from its merger with BHP Petroleum, and Santos from its merger with Oil Search. These mergers have improved the balance sheets of both businesses and give them more flexibility around the timing of when they invest capital in their existing assets. Also, the high oil price environment gives them a better opportunity to be able to realise better returns.

In the current environment commodity prices are driven by hard-to-predict macroeconomic events, and accordingly, prices can fluctuate aggressively over the short term. It’s impossible to predict how long this will last. At this point we are content to hold onto our current commodity exposures.

We think that over the long term, the current fears of a shortage of oil and gas will accelerate the push to renewable energy. Nonetheless, we believe that demand for LNG will remain strong over the foreseeable future as it is seen as a “transition” fuel to greater use of renewable energy.

Focusing on the long term

Markets will experience periods of uncertainty and heightened volatility from time to time, but over the long term, share markets typically deliver meaningful returns to shareholders.

In setting the AFIC portfolio, we do not attempt to capture all the short-term swings in market cycles. With so many external factors currently impacting the market, there are widespread potential outcomes for company earnings in the near term and the valuations applied to those earnings.

In this context we believe the portfolio is well positioned in quality companies that offer a sustainable competitive advantage, are well managed, generate growing free cash flows, and have strong balance sheets. We look to buy and hold our investments for the long term, not second guess market cycles.

As long-term investors we’ve been using the recent sell-off in quality companies to add selectively to some existing holdings. However, we remain cautious in the current market and believe we can afford to be patient for further opportunities.