May 24, 2024 Market Commentary | Commodity Craze
It’s a modern-day gold rush! Commodities have had a strong start to the year, with the GSCI (Goldman Sachs Commodity Index) up 9% and driving what we believe is the second leg of a bull super cycle. We’ve seen appreciation across the board, including natural gas, crude oil, gold, silver, copper, uranium, and even orange juice futures (for my fellow lovers of Trading Places).
What is a Commodity Super-cycle?
Commodity returns are uncorrelated to those of equities and fixed income and have inflation-adjusted correlations of .15 and -.20 over the long term, respectively (1877 – 2022, per AQR). However, commodities typically move together over longer cycles of 15 – 20 years. Per Bloomberg, the average commodity bull market lasts 17.6 years and returns 247.2% whereas the average commodity bear market lasts 20.6 years and declines 59.6%. The most recent bear cycle (2008-2020) led to a drop of 73.2%. However, since 2020, commodities are up 80.8%, and we believe we are still in the early stages of this bull super-cycle.
Sources: Bloomberg and Wells Fargo Investment Institute. Daily data. 2020 – current bull super-cycle uses Bloomberg Commodity Index from March 18, 2020, to March 31, 2024. 1999 – 2008 bull super-cycle uses Bloomberg Commodity Index from July 13, 1999, to July 2, 2008. 1971 – 1980 bull super-cycle uses Reuters Continuous Commodity Index from October 4, 1971, to November 20, 1980. The Reuters Continuous Commodity Index is an equal-weighted geometric average of commodity price levels relative to the base year average price. The Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements. The index rebalances annually, weighted two-thirds by trading volume and one-third by world production, and weight-caps are applied at the commodity, sector, and group level for diversification. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Super-cycle = If you look at commodity prices over the very long term (hundreds of years), it becomes evident that they tend to move in overall bull and bear cycles, some lasting decades. These are super-cycles.
High Inflation = Commodity Returns
We are still battling persistent inflation post-pandemic while the Fed maintains restrictive policy to get price increases under control. During the last commodity bear cycle, inflation rates were consistently below 2%. The long-term average is 2-3%. Since 2022, inflation peaked above 9% before stabilizing more recently in the 3 – 4% range. We believe that inflation will hover above the Fed’s 2% target for an extended period, and that rates are not going back to the low interest environment we experienced for the last 15 years. Historically, commodities generated 12+% annual returns when inflation was between 2 – 4% and 20%+ annual returns when inflation was over 4%. Per Standard & Poor’s, commodities also returned 10%+ annually during years of restrictive policy from the Fed.
Recreated from chart in Seeking Alpha article “Commodities Deliver Double Digit Returns in Face of Stubborn Inflation”
https://seekingalpha.com/article/4684663-commodities-deliver-double-digit-returns-in-face-of-stubborn-inflation
Demand-driven Tailwinds
• China’s demand coming back online increases the need for materials across their manufacturing industries
• Deglobalization and increased divergence between Western and Eastern world economies have spurred governments to substantially increase gold purchases to bolster reserves
• Increased fears from geopolitical conflicts and large US government deficits have also increased retail/institutional gold investment
• Continued transition to green energy initiatives/lowering carbon footprint have stimulated new demand for nuclear energy generation, driving uranium demand globally
• Global electric vehicle transition continues to lead to more demand in lithium, nickel, cobalt, nickel, and copper
• AI revolution is driving substantial demand for copper in data center development
Portfolio Positioning
Real assets may help diversify investors’ portfolios and smooth out volatility over the long run. Given that we expect to see structural headwinds for REITS/real estate exposure during a period of higher rates, we believe commodities should have a better return profile within a real asset allocation in portfolio with less reliance on interest rates coming down. Whether incorporating commodities exposure for tactical or strategic purposes, assuming that it fits within an investor’s risk tolerance, we believe that the case is strong to add to this asset class and expect that we are only in the beginning stages of this commodity bull super-cycle.
As always, please reach out to you financial advisor with any questions or concerns.
-The Seventy2 Capital Team
Commentary and Research provided by:
Michael Levitsky, CFA®, CAIA® - Managing Director, Investment Strategy
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC. Seventy2 Capital is a separate entity from WFAFN. The report herein is not a complete analysis of every material fact in respect to any company, industry or security. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
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