Key Points
- Positive forecasts for oil and other commodities should help the best stocks within the sector to outperform
- Generous dividend yields could provide income potential
- The high correlation between commodity prices and the share price is a risk
Over the past month, commodity stocks have been performing well. For example, the Anglo American share price is up 17% in the past month, with Rio Tinto also up almost 15%. Stronger commodity prices have helped to spur this move on as we’ve started the new year. Yet when I look further down the line, I think that these type of companies could be some of the best stocks for me to buy now for potential further gains.
A positive outlook
Firstly, the outlook for many core commodities looks much better than it did last year. For example, Rio Tinto mines a good amount of iron ore. This is consumed in a large part by China, as a component of steel production. Iron ore prices fell through the floor late last summer with concerns about demand from China. This appears to have been just a scare, with iron ore prices now bouncing back. I think that China is still in a good position going forward, so I think iron ore prices can keep pushing higher.
Oil is another example of a commodity showing strength. The West Texas Intermediate crude benchmark oil price has jumped from $70 per barrel a month ago to trade at $82 currently. This has helped shares of companies like BP and Glencore move higher by double-digits in the past month. If the world economy sees more travel during 2022, then oil should continue to be in demand for refined outputs such as fuel. As a result, it should make these some of the best stocks to buy now.
Income potential from top stocks
A second reason to like commodity stocks is due to the generous dividend yields. When I look at the current yields on offer, most sit well above the FTSE 100 average of 3.32%. In fact, four of the top 10 highest yield stocks are mining companies. This includes Rio Tinto with a current yield of 9.17%.
This yield is one reason why I might want to consider buying now versus later on. One element of the dividend yield calculation is the share price. If the dividend per share stays constant, a higher share price reduces the dividend yield. Therefore, if I think that these companies will do well this year, I’m better off buying now instead of waiting for a few months.
Risks to consider
It isn’t all good news for commodity stocks. Over a longer one-year period, some of the companies are still in the red. For example, Polymetal International shares are down 29% over this time frame. Therefore, it’s important for me to be selective about which companies I judge to be the best stocks to buy now.
Another risk is that there’s a high correlation between share price movements and commodity prices. So even if the company does everything well internally, it still might see profits decline simply due to lower commodity prices.
