The global commodities complex is wrapping up a truly forgettable decade. The spot price for staple crops such as corn, cotton, and soybeans are now 10% to 20% lower than the start of the decade. Crude oil is now around 25% cheaper and natural gas prices trade at less than half their decade-ago price, according to Bloomberg.
Roland Morris, a portfolio manager and strategist for the Commodity Index Strategy team at VanEck says that a great many things worked against commodities in recent years. He points to sluggish global growth, various markets that were oversupplied, a strong U.S. dollar, confidence-sapping trade wars, and quiescent inflation pressures as key headwinds.
Morris has been overseeing commodities-focused portfolios for 25 years and has seen several booms and busts along the way. Yet he now sees a backdrop that is shifting from headwinds to tailwinds.
“I’m now turning more constructive on commodities,” he says, adding that monetary stimulus plans put in place over the past year or two should give a significant boost to global growth. Why aren’t we seeing these moves reflected in commodities prices yet?
“There’s a long lag time when it comes to positive and negative factors impacting the commodity segment,” says Morris. He expects the impact to be felt starting in 2020 and building from there.
In addition to fiscal stimulus and very accommodative monetary policies, the recent resolution of the trade spat with China should also help lift global economic spirits. Many countries rely on China as a key trading partner and would surely benefit from a rebound in the world’s second-largest economy.
In mid-December, we learned that Chinese retail sales and industrial output grew at a faster-than-expected pace. Industrial output for November, for example, was 6.2% higher than a year earlier, compared to 4.7% yearly growth in October.
If economic conditions indeed strengthen in 2020, it could create a reversal in currency markets. Morris says that stronger growth “should lead to a weaker dollar after an extended period of dollar strength.” And that would be a plus for global commodity prices—and demand. Indeed, the dollar and the Commodity Research Bureau (CRB) Index have tended to trade inversely over the years.
That’s because the U.S. dollar is the benchmark pricing mechanism for most commodities. When the value of the dollar drops, it costs less for other nations to purchase a fixed volume of a commodity.
While the demand case for commodities should strengthen if global economic growth rebounds in 2020, the supply side of the equation should also become more favorable.
With commodity prices in a slump in recent years, many new mining projects failed to get the green light. Morris notes that mining output for copper, zinc, and nickel were all hurt by weak prices. Yet he says that “low prices fix themselves. As investment comes out of production, oversupplied markets become undersupplied.”
And that supply factor may be in place for quite a while. “Industrial metals projects take up to 10 years to develop,” says Morris. “I could envision copper, for example, making a substantial move higher over the next five years.”
That rally may already be underway. As soon as it became apparent in early December that the trade war with China was cooling off, copper futures have rallied nearly 10%, though they remain 40% below levels seen back in 2011.
To be sure, the decade-long bull market for equities (and 30-year bull market for bonds) have given advisors little reason to consider commodities in client portfolios. But that’s starting to change.
Dennis Nolte, a financial advisor with Florida-based Seacoast Bank, saw no need to add exposure to commodities — until recently.
“We’re now dipping our toe in the water with commodity funds, allocating 3% to 6% of portfolios to commodity funds,” he says. Nolte concedes that the exposure makes little sense for advisors that simply promise clients that they will passively match stock and bond market benchmarks.
Yet for advisors that pursue more active management, the advisor sees commodities as providing a crucial form of portfolio protection in the event that global economic conditions shift in 2020.
Buying and selling commodities contracts for clients requires a Series 3 license, which many advisors lack. Instead, advisors should consider commodities-focused funds for targeted exposure. Nolte eschews funds that own commodity-producing companies. “You’re still getting equities exposure with those.”
Instead, Nolte prefers ETFs that are focused on commodities contracts themselves. With $1.65 billion in assets and a 0.58% expense ratio, the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (ticker: PDBC) is a popular choice. The fund invests across 14 different kinds of commodities without a heavy weighting in any particular area.
VanEck’s Morris oversees the VanEck Global Hard Assets Fund (GHAAX), which carries a 1.38% expense ratio and $696 million in assets. The fund managers currently have around a third of the portfolio in metals/mining and another third in oil/gas/consumables, though fund weightings can shift as market conditions change.
Having overseen commodities funds since the 1990’s Morris is familiar with all kinds of economics cycles, and sees parallels developing between the current era and the early 2000’s. Back then, Morris says, “we had a weaker dollar, stronger global growth and economies moving closer to full capacity, all of which are factors that can lead to inflation.”
It was a backdrop that was quite favorable to commodities. At the start of 2002, the CRB index stood at around 120. By the summer of 2006 the index had surged above 300, before peaking above 450 in the summer of 2008.
While it’s premature to consider any sort of massive rebound like that for the coming years, it’s increasingly clear that commodity prices have a series of catalysts to fuel a steady upward march.
David Sterman, CFP, is President of New Paltz, NY-based Huguenot Financial Planning.