Why Rallying Commodities And Oil Prices Could Send The FTSE 100 Soaring

Two years of plunging commodities and oil prices may have left consumers with extra cash in their wallets, but they’ve also dented the portfolio of nearly every investor. It’s no secret that the FTSE is heavily weighted towards extractive industries, and as these shares have tanked over the past two years, they’ve dragged the market as a whole with them. However, with signs emerging that the bottom may have been reached for everything from copper to zinc, is the FTSE set to skyrocket?

The quick and spectacular crash in commodities prices from their 2014 peak has caused the FTSE 350 Oil & Gas Producers Index to fall 24% and the FTSE 350 Mining Index to drop a full 46% since March of that year. Despite a strengthening domestic economy, the FTSE 100 has shed 8.75% over this same period, due in so small part to the aforementioned troubles in extractive industries.

The good news is that it looks as though this trend may finally be reversing itself. Since reaching lows on 20 January, the Bloomberg Commodity Index is up 8% and Brent crude prices are up a staggering 43%. Futures prices suggest the market is expecting we have hit a bottom in major commodities prices, although future growth will not continue at the torrid pace it has over the past months. 

Positive response

The market has responded well to this and quietly sent share prices of major miners soaring; Anglo American is up 140%, Glencore 96%, BHP Billiton 45%, and Rio Tinto 32%. Rising commodities prices aren’t the only thing sending share prices into this dramatic move upwards. Large commodities and oil producers are coming out of this crisis with dramatically de-leveraged balance sheets and are more focused on low-cost-of-production assets, both qualities that will help the shares continue their rise.

Unsurprisingly, the rapid appreciation of these blue-chip share have helped drag the FTSE 100 as a whole a full 8% higher over this period. This increase came despite poor performance from nearly every single large financial institution, the other pillar of the index.

Now, whether this rally in commodities and oil prices is set to continue is certainly a more complicated question. At least for oil, the rally appears to have a solid base in economic conditions. The rout in prices since 2014 has been due to oversupply, and unsustainable prices in the $30/bbl range would certainly bring supply down sooner rather than later.

Perversely, the cause for commodities prices rallying has been due to continued bad news from China. The market is, not wrongly, expecting the Chinese government to react to the slowdown the way it has for the past 40 years: a massive stimulus programme centred on infrastructure projects, which requires mind-boggling amounts of copper, iron and every other commodity.

Although oil prices may settle somewhere slightly above where they are today, it is unlikely they will continue to appreciate as significantly as they have in the past two months. And the story for commodities is even worse, with demand still shrinking and supply slightly increasing over the short term. So, although, a continued rally in commodities and crude prices would keep the FTSE 100 soaring, I believe the market will have to look to other sectors to maintain this positive growth. 

While their recent uptick could last some time, investors would do well to remember that commodities, oil & gas producer's shares remain highly cyclical. Investors who are interested in shares with more stable performance should check out the Motley Fool's latest free report, Five Shares To Retire On.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.