A combination of increasing inflation, the late-cycle position and the low correlation commodities have with other asset classes could stand to benefit them over the medium term.
This is the reason Rory McPherson, head of investment strategy at Psigma Investment Management, says the firm is ready to re-enter the market despite the prolonged period of awful performance.
He believes commodities are poised to perform because it is one of the few asset classes that has lost money in the bull market. Since 2009, commodities are down about 10% compared with equities that are up 300%, high yield bonds up 200% and even government bonds up 50% (see chart).
Despite this appalling run, McPherson believes the late-cycle environment favours commodities and they tend to respond well to real growth, compared with equities which rally based on expectations of future growth.
McPherson says manufacturing demand is a big kicker for commodities, so one has to believe that manufacturing purchase managers’ indexes (PMIs) and growth will stay positive. The latest IHS Markit PMI for the UK hit a three-month high of 54 in May for the services industry, up from 52.8 in April.
“Many commodities are under-supplied due to a big period of de-stocking post the 2007 boom and then bust, ie if real growth picks up then prices will be pushed up,” he says.
Delivering for shareholders
Ben Yearsley, director at Shore Financial, says commodity companies learnt a harsh lesson at the end of the last cycle with value destroying M&A, so this time round they are more focused on delivering cash to shareholders.
“They also haven’t invested in much new capacity which in theory is good for pricing,” he adds.
Columbia Threadneedle head of commodities David Donora agrees that the supply side of the market is not increasing production, rather talking about creating value for shareholders which is a “big change”.
“It has a lot to do with having gone through a seven-year bear market in commodities and it is really only in the last 12 months they have begun to have a little bit of relief from what was a relentlessly difficult time,” he says.
Inflation hedge
Commodities have also historically been one of the most effective ways to hedge against unexpected inflation, which is highly relevant in today’s market given recent increases in rates, particularly in the US.
UK inflation came in lower than expected in May, holding steady at a one-year low of 2.4%, but still above the Bank of England’s 2% target. However, analysts were predicting prices to climb marginally by 0.1% to 2.5%. But US inflation accelerated in May to reach a six-year high.
Ben Ross, co-portfolio manager on the Cohen & Steers Active Commodities fund, thinks inflation could pick up as global job growth continues and upward pressure on wages drives inflation higher.
“Commodities are often direct inputs to inflation measures and generally respond to the same forces that drive the prices for other goods higher, including stronger demand from increased economic activity, as well as supply constraints,” he says.
Future proof
So how to access commodities? McPherson says Psigma is looking at investing in commodity futures.
He explains: “This means we are getting exposure to the underlying physical asset, ie the bushel of wheat or the barrel of oil. Buying real assets such as these is very attractive from a diversification standpoint.”
Donora, who manages the Threadneedle (Lux) Enhanced Commodities Sicav, believes at this stage, the best way to access this is through a diversified commodity fund through an active manager.
But Yearsley says while he is not against holding commodities funds, he does not hold any now. He warns investors have to get timing right with the asset class – much more than with other more focused sector funds.
Yearsley argues one of the big reasons for not holding them is that the UK market is already commodity-heavy through oil and mining firms, with income funds having large existing weights.
“Do you need a specific fund when the UK market is already overweight?” he queries.
Demand
Donora says recent flows have largely come from institutional clients concerned about inflation. Wealth manager participation has been light so far, but that will change.
“Once commodities have rallied 30% it will catch their attention and then they get involved,” he says. “My view is a commodity bull market is when the market doubles or triples, so if you miss the first 10, 20, 30% it is not a big deal.”
He adds: “Year to date we are up 3% so not very exciting at all. I think we are one headline away [from a 30% rally]. Any significant disruption to the 100 million barrels per day of oil production and suddenly you need a new price point to incentivise growth.”
