NANR: Downgrade To Hold On Recession Fears

A few months ago, I wrote a bullish article on the SPDR S&P North American Natural Resources ETF (NYSEARCA:NANR), arguing that investors should own the NANR ETF to take advantage of strong demand for commodities in a supply-constrained world.

However, I also highlighted downside risks as the global economy inched towards a recession. Fast forward a few months and it appears the weakening economy has won out, as the NANR has returned -7.6% since my article while the S&P 500 has returned 3.1% (Figure 1).

Previously, I warned that "I would be more concerned if the price starts to break support ~$52". With the NANR ETF closing a hair below $52 on May 12th, let us reassess the prospects for the NANR ETF.

Brief Fund Overview

The SPDR S&P North American Natural Resources ETF provides exposure to U.S. and Canadian large and mid cap companies that operate in the natural resource and commodities industries including energy, metals & mining, and agriculture. The sector weights for energy, metals & mining, and agriculture are reset each quarter to 45%, 35%, and 20% respectively.

First A Boom...

As I noted in my prior article, the NANR ETF has a very pronounced 'boom/bust' returns profile because natural resource companies are price-takers, so their revenues and earnings are determined by the cyclical price swings of the underlying commodities (Figure 2).

The resource sectors earned bonanza returns after the COVID-pandemic, as supplies were constrained while demand rebounded. This caused the price of many commodities, for example crude oil, to rally sharply from their COVID-lows in early 2020 to their cyclical highs in 2022 (Figure 3).

This boosted the revenues and earnings of resource companies, as their business models usually exhibit large operating leverage. For example, if we look Exxon Mobil (XOM), the largest oil producer in the U.S., its total oil-equivalent production was essentially flat from 2020 to 2022 (Figure 4).

However, XOM's revenues and earnings soared from $178.6 billion and -$22.4 billion in 2020 to $398.7 billion and $55.7 billion in 2022 on higher commodity prices (Figure 5).

Individual resource companies have little say in the price of their products (contrary to what government officials would have you believe!), and their focus is to produce said commodities at the lowest cost possible and deliver them into a global market where aggregate supply and demand sets the price.

...Now A Bust?

However, since the Russia/Ukraine war induced price spike in early 2022, commodities have generally been on a downtrend, with WTI crude recently touching multi-year lows in the low $60s and wheat halving to ~$6 / bushel (Figure 6).

The main reason for weakening commodity prices appears to be deteriorating economic conditions. For example, in the U.S., manufacturing activity has been in contraction since late 2022 (Figure 7).

Furthermore, a recent U.S. regional banking crisis is set to further tighten financial conditions for consumers and businesses, as banks retrench and raise their lending standards. In fact, a U.S. recession appears to be the base case for many economists (Figure 8).

The problem for resource companies is that commodity prices tend to fall during recessions. For example, looking at WTI crude oil, prices tend to plunge during recessions (Figure 9). This is because for commodities like oil, supply tends to be inelastic, so when consumers and businesses reduce their demand during recessions, suppliers keep pumping (or digging), and prices collapse.

Similar patterns can be shown for other commodities such as copper (Figure 10).

Therefore, resources companies have been some of the worst performing in recent months, modeled by the returns of the Energy Select Sector SPDR ETF (XLE) and Materials Select Sector SPDR ETF (XLB) in the past 6 months, as investors price in a recession (Figure 11).

Technicals At Make Or Break

Technically, the NANR ETF is nearing 'make or break' levels that I highlighted in my prior article, connecting the uptrend since early 2021, as well as the $52 support level (Figure 10).

I believe NANR's price will weaken further, confirming the negative macro fundamentals highlighted above.

Conclusion

The NANR ETF provides exposure to mid- to large-cap natural resource companies in the U.S. and Canada. Resource companies appear to have entered a new bear phase on the back of weakening economic fundamentals. I am downgrading the NANR ETF as I believe a recession is now unavoidable.

The NANR ETF is on cusp of a technical breakdown that will confirm the weak macro-economic picture. I believe investors should take a stop loss and exit the bullish trade.