Implications of the Coronavirus for Natural Resource Investors

by Fred Fromm of Franklin Templeton Investments, 2/20/20

The coronavirus and the impact of containment efforts on global economic growth and oil demand is influencing investor sentiment and behavior, according to Franklin Equity Group’s Fred Fromm. Despite the outbreak’s near-term impact on commodity prices and natural resources stocks, he explains why he thinks the situation is likely to be manageable for most companies in the long run.

There’s no question the Novel Coronavirus has brought suffering to many people, and we certainly don’t wish to downplay the seriousness of the situation. It also has caused a sense of panic among investors globally, as we’ve seen some volatile market reactions in the wake of the virus’s spread. One prime example surfaced on February 3, when China’s commodity markets tumbled after re-opening following the Lunar New Year holiday. The question is whether the markets’ often panicky short-term reactions to these types of shocks are justified.

Although concerns related to the potential economic damage from the coronavirus and its containment efforts have weighed on commodity prices and related equity values, as we examine the situation through an investment lens, we believe the fundamental trends in place prior to reports of the outbreak are unlikely to change meaningfully. Recent economic reports have further supported signs of a recovery, and governments are likely to provide further monetary stimulus to help offset the virus’s downstream effects on economic activity. In addition, lower commodity prices can act as a form of stimulus by lowering costs to consumers, particularly for transportation fuel.

Quarantines in China, along with the government’s targeted closures of businesses and mass transit in regional hot spots, will influence commodity demand, but we believe the negative consequences should be short-lived as weather warms into the spring, the spread of the virus wanes and vaccinations and drug treatment regimens are developed. While the situation remains fluid, if history and the 2003 SARS (Severe Acute Respiratory Syndrome) epidemic are any guides, markets will recover—and perhaps strongly—once the virus is decoded and contained.

Meanwhile, the People’s Bank of China recently announced significant capital injections into the country’s banking system to help offset its slumping domestic equity market. However, concerns have lingered over the threat the Novel Coronavirus poses to global oil demand. The virus’s economic fallout is also tied to a range of other industrial commodities used in transportation and manufacturing. As the contagion spreads, commodity traders continually reassessed the impact of shutdowns in the world’s biggest energy user and producer of steel, coal, refined copper and other base metals.

China is the world’s largest oil importer and second-largest oil consumer—it currently uses roughly 13.5 million barrels of crude oil daily (mb/d), or nearly 10 mb/d more than it produces.1 Attempts to contain the coronavirus have crippled regional travel at a time when fuel stockpiles typically build on a seasonal basis. In this environment, the specter of oversupply has made crude oil extremely sensitive to demand concerns, even if viewed as short term in nature.

Global oil markets experienced some relief when the Organization of Petroleum Exporting Countries consortium (OPEC+), including Russia, announced a joint technical committee meeting to discuss the virus’s short-term impact on oil demand. In our view, OPEC could recommend temporary production curtailments, though Russia has been slow to confirm their position on the matter, which has raised some questions as to whether such a reduction will take place, furthering pressure on crude oil prices.