Copper is expensive, gold is stretched. Where Schroders is finding value instead

Despite the volatile reporting season and broadly solid results, both are being overshadowed by a bigger story in the bond market. Schroders' Head of Australian Equities Martin Conlon says the "tug of war" between bond and equity markets is what investors need to understand, and those implications flow directly through to company earnings.

Bond markets are growing increasingly uncomfortable with the scale of budget deficits, ongoing borrowing and persistent inflation. The other side of that equation, Conlon says, is that the volume of capital flowing through the system, from governments, private credit and AI capex is creating a strong operating environment for companies.

"Lots of companies have plenty of revenue growth. Where they do have pricing power, they're generally exercising it - and that means particularly for those companies benefiting from strong pricing environments, that results are pretty good."

Commodity stocks are a clear beneficiary, with gold companies enjoying an extraordinary pricing environment. Consumer Discretionary on the other hand is starting to feel the squeeze as higher rates work through the economy.

Why share prices moved so much

Conlon attributes the violent share price swings this season to a structural change in who prices equities, firmly dismissing the narrative that these rapid moves reflect market efficiency, an idea he calls "a lot of guff."

In reality, systematic quant investors and passive money are now the dominant pricers of equity markets. Where fundamental investors would historically have stood against outsized moves, that capital is no longer there.

"The reactions can, in our view, be crazy and way beyond what any fundamental move in the earnings justified," he said. A single result, good or bad, doesn't justify extrapolating forever. 

"We fundamentally believe that every company is a cyclical. Nothing grows forever. Trees don't grow to the sky."

What matters is where a company sits in its earnings cycle, whether it's over- or under-earning, and how much its fundamental value has actually changed. Those massive price moves are usually an opportunity for the Schroders team to go the other way.

"It's all about copper"

The dominant stock story for this reporting season was BHP (ASX: BHP). 

Head of Research Justin Halliwell drew a comparison - at the start of the year, CBA was around $30 billion larger than BHP by market cap. By the end of August, BHP was $70 billion larger and is now the ASX's largest stock at almost 12% of the index.

He doubles down on Conlon's point about cyclicality. BHP was worth US$65 billion in 2015, at the cycle bottom, below book value. Today it's around US$245 billion, at roughly four and a half times book. "If you know nothing else, you kind of feel like we're getting towards the top of the cycle," he says.

BHP's claim to be more than 50% copper also deserves scrutiny. Halliwell acknowledges the quality of the assets and the company's execution, but says they're "masters of the narrative." BHP reports Escondida at 100%, but only owns 58.5% of it.

"If you look at copper EBITDA for the year, they'll say it was 19 [billion]. Actually when you adjust for the fact they only own 58.5% of Escondida, it was more like 14 billion. So immediately you go below that 50%."

On the copper price, Halliwell is sceptical. The lift has been driven largely by tariff fears pulling inventory into the US rather than genuine supply-demand tightness.

"Given where global inventories are, where supply and demand is, the $6.50 copper price would be very hard to say that's a sensible price, probably more like $4.55 on the fundamental view."

Data centre demand for copper is real but modest - around 500,000 tonnes in a 30 million tonne market. "Yes, it's growing strongly. By the end of the decade it might've doubled, but we're talking about an additional 1% of demand."

BHP has now re-rated to match the pure plays, which Schroders has been flagging as expensive for months. Rio Tinto (ASX: RIO) is viewed as comparably positioned for the energy transition, with high-quality copper assets including the Oyu Tolgoi mine in Mongolia, and an aluminium business that benefits indirectly from electrification as data centre power demand constrains future smelting capacity. 

AI: inflationary for now

Every company claims AI productivity gains but finding them in the earnings is another matter.

Equities analyst Jennifer Odjugo points to two high-profile layoffs attributed to AI - Block (4,000 roles) and WiseTech (2,000). Block had grown from 4,000 to 13,000 employees through COVID; WiseTech had just acquired E2open and its 3,000 staff. In both cases, she says right-sizing is the more likely explanation.

In the short term, AI is proving inflationary. Apple have raised prices by more than 20% and memory chips have seen sharp increases. The deflationary case, one of AI's great promises,  remains unproven.

In Odjugo's view, any financial benefit from AI productivity will likely flow to the platforms, not the companies using them.

"If there is any financial benefit to come from the AI productivity gains, that value probably flows through to the LLMs and the AI companies of the world and hardly stays with the traditional firms."

The fear that AI would hollow out enterprise software has meanwhile eased. TechnologyOne (ASX: TNE) still trades at over 70 times earnings, Xero (ASX: XRO) at over 50 times.

Healthcare's comeback

CSL (ASX: CSL), Cochlear (ASX: COH), ResMed (ASX: RMD) and Ramsay Healthcare (ASX: RHC) all delivered strong results. 

For Conlon, this just confirmed Schroders long held views. "We always thought they were good companies and we don't believe anything much has changed."

CSL is the clearest example. A stock that once traded at 40 times earnings had fallen to around 11 times, one of the lowest multiples on the market.

"We were scratching our heads as to what other people were seeing there that said this company has lost its way forever."

The result confirmed the earnings trough had passed, market share was being rebuilt, and the cost advantage in plasma fractionation remained intact. 

Cochlear's activity levels are recovering. Ramsay, under genuine operational pressure, has used this well by improving utilisation, cutting costs and implementing technology.

"Perversely, it's one of these things where companies going through hard times can be amongst the best things for them. It's generally when you get the best cost gains."

Gold: running ahead of itself

Gold companies made up 18 of the ASX's top 20 performers last month. But Odjugo points out that while many gold equities are at all-time highs, the gold price itself sits roughly US$1,000 below its own peak. The equities have run beyond the commodity.

The structural shift in gold's drivers began with Russia's invasion of Ukraine in 2022, when its relationship with bond yields broke down. 

Central banks, uneasy about USD reserves, began buying in size and repatriating holdings, keeping prices elevated independently of real rates. Gold equities have run further still, and Odjugo attributes much of that to momentum.

"Gold equities are riding beyond where the gold price is at the moment, and that's partly driven by where multiples are. Investors seem to be willing to pay up more for these gold equities than they were a few months ago."

Conlon has long been cautious on gold which he says is largely behavioural, offering inflation protection because people believe it does. 

Instead, the team holds real, productive assets as its inflation hedge - resources and companies with pricing power, while staying underweight financials.

"You can't have it both ways. You can't believe there are no problems in the banking system, that all financial assets are sound, yet you also believe that gold's the only thing you should own."