Jeremy Grantham's GMO says investors can still make money on commodities stocks — and should load up on fossil fuel names as the world transitions to clean energy

• Even after the rapid rise of commodity prices, it's not too late for investors to buy energy stocks, according to Jeremy Grantham's GMO.
• GMO highlighted attractive valuations and favorable supply and demand dynamics that suggest there's plenty of more upside ahead for commodity stocks.
• "The clean energy transition will take decades to play out and will, in fact, be a major driver of commodity demand," GMO said.

Most investors probably think it's "too late" to purchase energy stocks given their impressive one-and-a-half year long rally, which has led to significant outperformance relative to the broader markets.

But Jeremy Grantham's GMO laid out the case for why now is still a good time to load up on energy and other commodity-related stocks, even after the energy selector has outperformed the S&P 500 by more than 120 percentage points since the start of 2021.

It all comes down to supply and demand, and even when one considers the ongoing transition to clean energy, there is simply not enough supply of hard natural resources to keep up with what will continue to be very strong demand, GMO's Lucas White explained the firm's its first-quarter letter.

"On the demand front, we have a global population rapidly approaching eight billion and headed significantly higher from there. More importantly, a large proportion of the global population resides in developing countries that will continue to go through the stage of economic development that is particularly commodity-intensive for decades," White explained.

That, combined with much of Russia's resource production being virtually cut off from global supply chains, means lasting higher prices are likely for many commodities. Even a transition to a clean energy world won't end the world's need for natural resources, as copper, lithium, nickel, and cobalt are all essential to powering the future clean energy grid.

"Population growth, economic development, and decarbonization pretty much guarantee substantial, potentially explosive, growth in commodity demand," White summarized.

But while there will be incredible demand for the commodities, supply won't be able to catch up, as many oil companies have been reluctant to invest in more capital expenditures after experiencing such a long stretch of incredibly low commodity prices and pressure from ESG and divestment circles.

That period of time, which essentially led to a lost decade for energy stocks, has oil companies choosing profits over growth, in what is essentially a self-reinforcing cycle. Those profits only go higher as they hold back reinvestments, and holding back reinvestments leads to a continued lack of supply, which leads to higher prices, which translates into more profits.

Capital expenditures in the resources sector have dropped to a 15-year low of about $150 billion, according to GMO.

"If investment in production is constrained, fossil fuel prices could stay high even as we eventually displace demand [with clean energy]. On a recent quarterly earnings call, BP CEO Bernard Looney took a page out of my book and said much the same: '…you could see a world where because of lack of investment, even though the energy transition is accelerating, oil prices are much, much higher," White said.

With an encouraging supply and demand backdrop for energy stocks, the deal for investors to buy energy stocks gets even sweeter when you consider current valuations, according to the note. Resource companies still trade at a 60% discount relative to the S&P 500, even after their monster rally.

"The market is simply not valuing resource companies at reasonable levels given any plausible base case for how the world might play out," White said.