Commodities haven’t had it easy lately. Depending on who you talk to, commodities have been in a bearish slump for six to nearly 10 years. While the S&P 500 index has been on an upward climb since 2009, the Invesco DB Commodity Index Tracking Fund (ticker: DBC) has been stumbling along, losing more than gaining.
Weak global growth and low demand has “kept commodities in the penalty box,” says Amanda Agati, co-chief investment strategist at PNC Financial Services Group in Philadelphia. But the tide may be turning in commodities’ favor.
After a decade of surplus following the Great Recession, we’re finally at a point where demand for commodities is exceeding supply and prices are rising, writes John Creswell, executive managing director at Duff & Phelps Investment Management in Chicago, in an email. Most of this demand is coming from emerging markets.
[See: 7 of the Best Emerging Market Stocks to Buy.]
The demographics behind the demand. The two primary drivers of demand from emerging markets are their growing working-age populations and rising standards of living, says Mark Carlson, senior investment strategist at FlexShares in Chicago.
While developed populations are gradually grinding to a gray-haired halt, the working-age populations in developing nations are growing. “The global middle class continues to grow at an unprecedented rate, with emerging economies, driven by China, India and Southeast Asia, expected to grow at 6 percent compared to 0.5 percent for developed economies,” writes Maxwell Gold, director of investment strategy at ETF Securities by Aberdeen Standard Investments in New York, in an email.
As a result, more people are entering their peak working and consumption years in emerging markets than in developed nations, Carlson says.
At the same time, the standards of living in emerging economies are rising. “As people get richer, they want to buy a car and drive it. They want to increase their electricity use. They want to eat a higher-protein diet,” says Leigh Goehring, managing partner at Goehring & Rozencwajg Associates, a commodity-based investment firm in New York. In other words, they want to consume more commodities.
The commodities that will gain the most. “Never have so many people been in a period of high commodity consumption as now,” Goehring says, particularly oil, natural gas, copper and agricultural commodities.
We’ve already seen outsize gains in industrial metals and oil, “with grains starting to perk up over the last few months,” writes New York-based Ed Egilinsky, managing director and head of alternative investments at Direxion, in an email.
As diets shift to more protein, the demand for both livestock and the grains to feed farm animals will increase, Gold says. “Soy, corn and wheat are expected to see marked rises in consumption stemming from emerging market consumers.”
Soybeans, a protein source also used in cattle feed, will benefit the most, according to Chris Gaffney, president of world markets at TIAA Bank in St. Louis. Investors can also expect increases in dairy and sugar (once the sugar glut in India dissipates) as wealthier emerging market households add more of both to their diets.
“It all comes back to natural resources,” Carlson says, but it’s not just the conventional ones that come to mind first. When FlexShares developed its Morningstar Global Upstream Natural Resources Index Fund ( GUNR), it emphasized water resources, too.
[See: 7 Great Ways to Buy Energy Stocks.]
“The availability of usable water supplies can be a constraining factor in terms of economic development,” he says. As the emerging nations continue to grow and develop, they’re going to need accessible water supplies to support their populations.
But emerging markets aren’t developing the way they used to, Agati says. China in particular, which makes up about one-third of the MSCI Emerging Markets Index, has shifted from an old-world infrastructure-heavy economy to a services-based economy, she says. So “what fueled the [infrastructure] boom over the last cycle is unlikely to repeat itself.”
Instead, she says we’ll see new demand for renewable energy and technology-driven commodities. “China is the world’s largest solar panel installer,” with double the installation rate of the next two countries, the U.S. and Japan, combined, she says. China is also on the path to becoming one of the largest markets for electric vehicles, with GM targeting 500,000 new energy or electric vehicle sales there per year by 2025.
Overall, the continued push by emerging market countries, particularly those with large populations like China and India, to improve their standard of living will create a “major tailwind [for commodities] over the next few years,” Egilinsky says.
Avenues for investment. For investors the message is clear: Now is the time to overweight your commodities exposure, Gaffney says. There are a few ways to do that.
You could invest in individual commodity stocks. In this case, you might target multinational agricultural companies that will benefit from the changing diets in emerging nations, Gaffney says.
At Flexshares, fund managers look for companies with business models that emphasize the ownership and development of the commodities themselves — companies like Monsanto Co. ( MON), Exxon Mobil Corp. ( XOM) and BHP Billiton ( BHP). This ensures the company’s valuations are driven by the value of the commodities it owns and by development, Carlson says.
For broad-based commodity exposure, Gaffney suggests the Powershares DB Commodity Index ETF and iShares S&P GSCI Commodity-Indexed ETF ( GSG). Both funds do a good job of tracking the general commodity market, he says. They also don’t use any leverage, which he says is generally preferable for individual investors.
Investors can also take a country-centric approach to commodities, Gaffney says. As commodity demand in emerging markets rises, the countries that supply those commodities should benefit. Because China will be a key source of global demand, countries that have strong trade relations with China will gain the most. These include Australia, New Zealand, South Africa and Brazil, he says.
[See: 8 Commodity Plays Ripe for the Picking.]
“Investors can buy into those countries through [their] currencies or by buying their general stock market,” he says. “Right now, we like commodity currencies.”
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How Emerging Markets Will Fuel Commodities originally appeared on usnews.com
