As individual investors and financial advisors seek to hedge against inflation risk in their portfolios, commodity and precious metal investments are increasingly on investors’ minds.
These real asset investments are better able to retain their value when the value of the dollar falls. But there are other factors at play that may affect commodity prices such as decarbonization, which is a focus for three of the largest global economies, and could have a major impact on oil prices.
To get a clearer picture of the commodity and precious metal markets, we spoke with Robert Minter, director of ETF investment strategy at Aberdeen Standard Investments.
Investments in Aberdeen’s commodities and precious metal exchange-traded funds have risen 180% to nearly $7 billion in assets under management since 2018. So, naturally, the team is keeping a close eye on this market. Here are edited excerpts from that interview.
There have been strong flows into commodity funds for most of this year. Do you expect the rally to continue? Why?
Investors want to participate in the global economic reopening and have purchased commodity funds as part of a cyclical trade. It is important to remember the strong inflows are off very low levels, which make the flows more sustainable. They were strong early this year as the vaccine rollout picked up, retreated mid-March amid worsening virus news and have recently rebounded as vaccination rates have increased. The U.S. is one of the vaccine success stories, but even there, only slightly more than half of the adult population is fully vaccinated. The pandemic is not over, and the rise in economic activity has not been felt worldwide.
There were several areas where commodities positioning looked crowded to us, including grains and lumber. Grains were crowded on dire drought outlooks, which have abated marginally due to Midwestern rains. Lumber positioning softened as some homebuilders stopped taking orders until the homes were nearly completed, reducing backlog. But supply remains constrained in a number of energy markets and in industrial and precious metal markets.
We believe the strong flows will continue as developed markets like the U.S., United Kingdom and European Union reopen further, spurring demand for goods and services. Data from the Bureau of Economic Analysis revealed that consumer spending in the U.S. increased considerably during the first quarter of 2021. Simultaneously, many commodity producing nations will struggle to ramp up production, with lingering supply restrictions and disruptions that could lead to persistent higher prices.
What investment vehicles should investors and advisors consider if they want to gain access to commodities and precious metals?
Investors can own or gain exposure to commodities in several ways, from physical ownership to futures contracts. But some are more advantageous and practical than others. Commodity ETFs, in particular, have numerous benefits that investors may take advantage of, including unique structuring options that aren’t available elsewhere.
At a high level, commodity ETFs may help investors mitigate broad market-level risk, since these ETFs endeavor to track underlying commodities, giving them little to no correlation to equity market performance. The unique ETF structure also offers investors access to a growing market with high levels of liquidity and provides greater transparency into their commodity holdings, all while lowering their costs and improving tax efficiency in many circumstances.
What role should commodities play in a client’s portfolio?
One of the main reasons we believe commodities are a vital part of a long-term portfolio is their low correlation to traditional asset classes, such as equities, fixed income and alternatives.
Historically, individual commodities even have a low correlation to each other. As a result, holding a variety of commodity sectors may decrease volatility, provide a hedge against rising inflation and enhance overall performance in a diversified portfolio.
Recent consumer price index numbers have been significantly higher than expected. And in May, consumer prices showed the fastest inflation since 2008. Do you expect ongoing inflation to help or hurt investment demand for commodities and precious metals?
The question on inflation is whether it is transitory or more structural. Federal Reserve Chair Jerome Powell recently said that one-third of the inflation came from used car price increases. A temporary chip shortage has reduced new car inventories to one-sixth of normal levels, pushing used car prices 40% higher over the last year.
This type of temporary inflation doesn’t justify a tightening of monetary policy while millions of people remain out of work and there is an active global pandemic. It appears Powell and New York Fed President John Williams agree that monetary policy will remain supportive for some time, despite the voices of some dissenting Fed presidents who do not vote on policy.
The more structural sources of inflation will show up with a lag. The labor market was disrupted last year, and companies will need to pay higher wages to get workers off the economic sidelines. Additional inflation could be caused by deglobalization and decarbonization trends.
Central bank balance sheets have swollen, and since Jan. 1, 2005, the U.S. Fed’s balance sheet has risen 891% and the European Central Bank balance sheet has risen 785%. This argues for an allocation to precious metals as a structural piece of portfolios.
Decarbonization is a focus for the three largest economic blocks on earth: China, the U.S. and Europe. How do you think oil and environmental metals will be affected by the energy transition?
China, the United States and European Union represent a combined $51 trillion worth of gross domestic product — and all of them are trying to decarbonize their economies by shifting toward renewables.
It is effectively a shift from consuming fossil fuels to consuming materials. If this direction of travel continues, then the demand for the environmental metals used in renewables and electrification will increase significantly.
One way of considering the potential from decarbonization is to look at the last commodities super-cycle, which was driven by China’s industrialization. The Bloomberg Commodity Index, a broad-based index, returned 220% in the following 10 years.
That super-cycle started around 1999 when Chinese GDP was $1.2 trillion. The combined GDP of China, the United States and Europe today is 42 times larger than China’s GDP in 1999. Simply put, there will be no energy transition without an environmental metals super-cycle.
Any other themes that investors should be aware of for the rest of 2021 and beyond?
Deglobalization could have a considerable impact on inflation, and by extension, commodities. For years, the trend of ever-increasing globalization has added a deflationary pulse to economies, as manufacturing and consumer-product production have moved to emerging economies with cheaper labor.
But now, this is reversing. President Joe Biden has increased the focus on competing with China as an adversary. At the recent G-7 meeting, he emphasized China as a growing threat to global democracy. European leaders were quick to remind him of the importance of China’s partnership on climate issues. Some corporations now worry that it may even be necessary to decide whether they will transact exclusively with either China or its rival Western nations.
If this continues, and global supply chains become local supply chains, the steady deflation from goods prices could easily go in the opposite direction. Investors may look to participate in this inflationary shift by increasing allocations to commodities and precious metals.
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