We find that this is hardly the case.
Many commodities often show relative price stability during extreme market events. They generally enjoy low correlation to other asset classes. Investors that add a commodity allocation to their portfolios may benefit from diversification properties in any market environment – particularly the one ahead of us.
What are commodities?
In their simplest form, commodities are the physical ingredients that make up our day-to-day lives. They're the food we eat and the coffee we drink, as well as the sugar we can use to sweeten it. They comprise the raw materials in our clothing and homes, and include the energy that powers our electronics and vehicles.
When commodities are traded, they're typically sorted into several broad categories. The Bloomberg Commodity Index divides them into the six groups listed below, in order of descending index weighting:1
- Energy – Substances that are processed to generate power and heat, such as natural gas, coal, uranium and crude oil, which is most heavily traded commodity in the world
- Grains – Cultivated cereal crops used as food, such as corn, soybeans, wheat and oats
- Industrial metals – Base metallic elements, including copper, aluminum, zinc and nickel, which have numerous commercial applications
- Precious metals – Rarer metals, including silver and gold, which are often used in jewelry or employed in various fields (e.g., medicine, electronics) for their unique chemical qualities; the precious metals platinum and palladium are important in the automotive industry
- Softs – Non-grain materials that are farmed (rather than mined or extracted like “hard” commodities); coffee, cotton, cocoa and orange juice are a few examples
- Livestock – Animals often used for labor or food, including cattle, hogs, and poultry
The prices of these basic goods are often driven by supply and demand. Decreases or disruptions in supply tend to drive commodity prices higher, while supply surplus or reduced demand typically moves prices lower. However, outside influences, such as the shift to renewable energy or large consumers entering the market, may also impact commodity prices.
A broad allocation to commodities has its merits
Because commodity prices generally do not move in lockstep with the prices of stocks and bonds, a commodities position may be an attractive complement to an investor's other portfolio allocations. Investors can gain this exposure in several different ways, each with its own advantages and disadvantages. Investors seeking to harness these potential gains must first determine exactly how they would like to implement their commodities exposure.
Significant diversification opportunities
We believe that effective diversification is a critical aspect of asset allocation. Investors may realize significant value when different sleeves of their portfolio are less correlated with each other. Yet, there's a market trend that has evolved in recent years: Some sectors previously considered to be uncorrelated have begun to behave more alike during times of market stress. In other words, when investors need diversification the most, they aren't always able to find it where they used to.
Commodities may provide investors with effective diversification. That's because, at the asset-class level, commodities generally do not heavily correlate to other segments of the market. The fairly low correlation (and, in some situations, almost no correlation) that broad-based commodities exposure may bring to investors' equity and fixed-income portfolios potentially help lower risk and improve returns.
These potential diversification benefits have been repeatedly shown during risk-off scenarios and market sell-offs, when commodities held up well against other asset classes (Chart 1).
Chart 1. Commodities (like gold) have historically displayed low correlation with equities during major market events
Source: Bloomberg, Aberdeen Standard Investments. Global Equities = MXWO Index, US Equities = SPXT Index, Spot Gold = GOLDLNPM Index.2,3,4 Event date ranges evaluated from: 2007 Chinese Stock Bubble (2/01/2007–11/30/2007), 2008 Global Financial Crisis (9/1/2008–2/28/2009), US Credit Downgrade (8/1/2011–8/31/2011), Yuan Devaluation (8/1/2015–8/31/2015), Brexit (6/1/2016–6/30/2016), and 2018 Pullback (10/01/2018–12/31/2018).
Different approaches to gaining commodity exposure
Investors can own or gain exposure to commodities in several ways. Each has varying degrees of practicality, and some may offer distinct advantages that others cannot.
One way to gain commodities exposure is purchasing and holding the physical commodity itself. However, oftentimes, this isn't feasible. While purchasing and securely storing gold in the hopes that it will appreciate may be possible for some investors, buying and maintaining large amounts of wheat or cattle until they reach a desired value is not. Although gold can be kept in a safety deposit box for extended periods of time, grains require large silos and cows need feed (and neither of the two last forever). Generally speaking, the storage and maintenance of physical commodities is prohibitively impractical for the average investor.
There are also future contracts (or “futures”), which are legally binding agreements to purchase or sell a specified commodity for a preset price at a certain point in the future. Futures can make it easier for massive commodity end users to budget their purchases – like an airline buying fuel, or a large grocery chain procuring beef. Investors can also purchase commodity futures, hoping to sell after they increase in value. However, only sophisticated investors can typically access the futures market, and while they may stand to realize significant profits, they assume commensurately higher risk in attempting to do so.
Investors can also buy stock in commodity-producing companies. For example, investors can buy shares of Exxon-Mobil to gain oil exposure. This option is more accessible for most investors, and – with proper research – may yield favorable results. However, these investors could be taking on more risk than they realize. In addition to the desired oil-price risk, Exxon-Mobile's investors are also assuming the operational risk associated with any company (accounting fraud, poor management), idiosyncratic company-specific risk (pipeline leaks, oil spills), and equity-market risk (reduced risk appetite, broad market sell-offs).
Commodity exposure through an ETF structure may offer distinct advantages
Exchange-traded funds (ETFs) are investments that collect a basket of securities, such as stocks, bonds or commodities, and most often track an underlying index. Because of the dramatic growth that the ETF market has experienced in recent years, investors have a wide selection of commodity ETFs to choose from. This provides them the chance not only to gain exposure to numerous commodities, but to choose from options that employ a range of investment strategies to help meet various financial goals.
Commodity ETFs, in particular, have unique benefits that investors may take advantage of, including unique structuring options that aren't available elsewhere. They may also 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.
At a high level, commodity ETFs may also:
- Give investors easier (and lower-risk) access to commodities, an asset class in which they might not otherwise be able to participate
- Lower investors costs by closely tracking underlying commodity prices and requiring less portfolio management activity5
- Improve tax efficiency with more favorable tax treatments on capital, short-term and long-term gains in many circumstances6
- Offer investors a growing market with greater amounts of liquidity, helping to streamline and facilitate trading throughout the day7
- Provide investors greater transparency into their commodity holdings, which ETFs often publicly disclose on a daily basis8
Know what you own
No two commodity offerings are the same, so it's important for advisors and investors to do their due diligence when considering commodity-oriented investments. One might tilt toward gold, due to its defensive characteristics during volatile markets (Chart 2). Another may favor copper, for its many uses in construction. Still another might focus on softs, which could benefit from an improving global economy if trade tensions ease. Many commodity indices are heavily weighted in oil, where risk is higher, but a price rebound may yield sizable gains.
Chart 2. Gold remained relatively stable through 2020 market volatility
Source: Bloomberg, Aberdeen Standard Investments. Data from 1/2/2020–12/31/2020. Spot Gold = GOLDLNPM Index, S&P 500 = SPXT Index, Russell 2000 = RTY Index, MSCI World Index = MXWO Index.9
No single commodity investment is inherently better or worse than any other; they each come with their own pros and cons, which can generate drastically different performance over a given time period. Because of the many variables at play, commodity investors must properly evaluate their options. It's critical to understand and consider the rationale behind an investment when determining a suitable allocation for particular risk appetites and investment goals. In other words, know what you own, know what you're buying.
After a super cycle: A recent history of commodity investing
For commodity investors, an important part of this principle is understanding why the asset class has fallen out of favor in the last few years. Coming out of the dot-com bubble in the late 1990s, commodities entered something of a super cycle. Inflation was running higher. Industrialization in many emerging markets (EM), especially Brazil, Russia, India and (even more so) China, was contributing to a growing middle class, creating a new population of commodity consumers around the globe.
All of this drove commodity prices significantly higher, until the financial crisis shook markets around the world in 2008. Despite a small recovery through 2011, commodity markets generally experienced a slow and steady decline over the past decade. They suffered under higher relative interest rates, a stronger U.S. dollar, EM weakness, widespread overproduction, and declining growth in China, where consumption had been a key driver of commodity performance.
The price of oil and other energy commodities particularly suffered. During the prior years' boom, liquidity was ample and investors were crowding into the energy space, as oil producers expanded to keep up with demand. After the market crash, this overproduction soon led to a supply glut, forcing oil prices down, and weighing on the commodities asset class, as a whole.
The current commodity investment landscape is brighter
Today, some of those challenges appear to have been resolved. We see several factors that suggest the environment through the windshield ahead of us may be more supportive of commodities than the backdrop in the rearview mirror.
Commodity prices may be set to follow inflation higher
A change in U.S. Federal Reserve (Fed) policy, the new U.S. administration and a potentially weaker U.S. dollar may point toward higher inflation – and when inflation increases, commodity prices generally follow.
The Fed's new inflation views
Recently, there has been a small but significant swing in the Fed's inflation stance. After many years of working to keep inflation low, the Fed has now said it would allow inflation to run moderately higher for some time, in order to help spur growth in the wake of the COVID market recession. For commodity investors, this marks an important shift. Since higher inflation generally allows commodity prices to increase, it is often positive for the asset class (particularly gold), as illustrated in the chart below. We believe rising inflation may be a driver of commodity prices going forward.
Chart 3. Historically, commodities have performed well in rising inflation environments
Source: Bloomberg, World Gold Council, Aberdeen Standard Investments. Data from 1/01/1970–12/31/2020. Spot Gold = GOLDLNPM Index. Inflation computed using annual US Consumer Price Index year over year changes between 1970 and 2019.10
Lower rates, a weaker dollar, and commodity prices near 20-year lows
Fed policymakers have also committed to keeping rates near zero, through at least 2023. These lower rates – along with ongoing fiscal stimulus – may help keep the U.S. dollar weaker. This, in turn, might also help to drive up inflation and buoy commodity prices.
Given US equity price levels amid the current low-interest-rate environment, we believe lower commodity prices may also present a compelling opportunity from a relative value perspective. As a point of reference, pricing for commodities has dipped to levels not seen since 2001.11 (And one would be hard pressed to find anything, let alone a barrel of oil, that costs the same as it did twenty years ago.)
Fiscal spending may drive additional commodity demand
The policies and priorities that President Biden has announced may also support commodity market performance, for a few reasons. First off, fiscal spending may increase the likelihood of inflation (and, thus, higher commodity prices). Perhaps more significant, federal funding for housing, infrastructure projects and sustainable initiatives may drive demand for commodities themselves. Both industrial and precious metals have a variety of construction uses, such as copper plumbing pipes, aluminum bridge framing, and the silver used in solar cells. What's more, putting federal stimulus checks directly into the hands of consumers may also support the commodities asset class. As people use that money to buy food, clothing and gas for their cars, they may boost commodity demand.
The processes for obtaining many commodities from the earth present certain environmental issues. Whether mining for zinc, drilling for gas or fracking for shale, extracting commodities generally leaves a lasting impact on the land. Such projects can use a significant amount of energy, cause erosion, create sizable pits in the ground or even leave behind detrimental byproducts, like wastewater or contaminated soil.
Yet, some of the commodities being extracted may also play an important role in contributing to a green society. Copper is used extensively in the motors, wiring and charging stations for electric vehicles (EVs), which continue to grow in popularity. As alluded to earlier, silver is a key component in solar energy; a typical residential solar panel contains up to 20 grams. Palladium and platinum are critical in the abatement of automobile emissions. They're both used to make catalytic converters, which help reduce pollutants in car exhaust.
The future of commodities in everyday life
In an overall sense, the reasons we use commodities are not likely to change significantly in the future. People will still need food to eat, clothing to wear, a home to live in and energy to heat that home. However, innovation may change the specifics of how we use a given commodity, which could benefit as new applications are discovered.
Innovation should continue to sustain commodity demand
As we touched on earlier, the development of EVs – whether car, bus, high-speed train or even airplane – wouldn't have been possible without certain breakthroughs in electronics and battery technology, which couldn't have happened without certain metal commodities. New smartphone models rely on these commodities, as well, as they contain small amounts of gold, silver, palladium and platinum (not to mention copper, aluminum and cobalt).
Such commodity-based innovations aren't just limited to electronics. Silver has many uses in medicine, some of which have been relied on heavily during the pandemic. Because it is broadly antibacterial, it's utilized in hospital linens, doctors' and nurses' gowns, and in the antimicrobial coating on medical equipment, among many other functions. Gold is used in the protective components of satellites, and also in aircraft windshields, due to its corrosion- and temperature-resistant properties.
Given that some of these applications have only been discovered in the past few years, it is fair to say that there's no telling what novel uses for commodities will be discovered in the days ahead – or how they'll drive demand.
An appealing opportunity today
In our view, there are compelling reasons for investors to consider a long-term, strategic allocation to commodities. Their low correlation to other market segments may provide attractive diversification benefits when paired with an investor's equity and fixed-income exposures. ETFs, in particular, can offer commodity investors certain unique opportunities that they can't find in other asset classes. While these evergreen merits of commodity investing may apply against any market backdrop, there are also many reasons we believe a commodities allocation could be especially suitable today.
The Fed has committed to keeping rates low and letting inflation run a bit hot, which may move commodity prices higher. We expect to continue seeing ongoing fiscal stimulus, a weaker US dollar and a flattening yield curve, which have historically proven supportive of commodities, as well. Given the risk of geopolitics and trade tensions creating market volatility, investors may be particularly interested in the low-correlation properties that commodity exposure may add to their portfolios. Moreover, with commodity prices near 20-year lows, we believe the asset class may present a compelling relative value opportunity.12
Investors that have a clearer picture of the factors and mechanics that affect the commodities market may be better positioned to harness its potential gains.
1 The Bloomberg Commodity Index provides broad-based exposure to commodities, and no single commodity or commodity sector dominates the Index
2 MXWO Index represents the MSCI World which is a free-float weighted equity index. It was developed with a base value of 100 as of December 31, 1969. MXWO includes developed world markets, and does not include emerging markets.
3 SPXT Index represents the S&P 500® which is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
4 GOLDLNPM Index represents the LBMA (London Bullion Market Association) Gold Price.
5 Brokerage commissions may apply and would reduce returns.
6 Tax efficiency is when an individual or business pays the least amount of taxes required by law. A financial decision is said to be tax-efficient if the tax outcome is lower than an alternative financial structure that achieves the same end.
7 Liquidity refers to the ease with which an asset, or security, can be converted into ready cash without affecting its market price.
8 Price transparency reflects the extent to which price and market information, such as bid-ask spread and depth, exist for a security.
9 The Russell 2000 Index is comprised of the smallest 2000 companies in the Russell 3000 Index, representing approximately 8% of the Russell 3000 total market capitalization.
10 Consumer price index measures changes in the price level of a weighted average market basket of consumer goods and services purchased by households
11 Bloomberg, February 2021.
12 Bloomberg, February 2021.
Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.
Trading in commodities entails a substantial risk of loss.
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS. The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of future results and subject to change. The reader should not assume that an investment in any securities and/or precious metal mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results
The Aberdeen Standard Gold ETF Trust, Aberdeen Standard Silver ETF Trust, Aberdeen Standard Palladium ETF Trust, Aberdeen Standard Platinum ETF Trust and Aberdeen Standard Platinum ETF Trust are not investment companies registered under the Investment Company Act of 1940 or commodity pools for purposes of the Commodity Exchange Act. Shares of the Trusts are not subject to the same regulatory requirements as mutual funds. Commodities generally are volatile and are not suitable for all investors. Trusts focusing on a single commodity generally experience greater volatility. Please refer to the prospectus for complete information regarding all risks associated with the Trust. Shares in the Trusts are not FDIC insured and may lose value and have no bank guarantee.
The value of the shares relates directly to the value of the precious metal held by each Trust and fluctuations in the price could materially adversely affect investment in the shares. Several factors may affect the price of precious metal, including:
- A change in economic conditions, such as a recession, can adversely affect the price of the precious metal held by the Trust. Some metals are used in a wide range of industrial applications, and an economic downturn could have a negative impact on its demand and, consequently, its price and the price of the shares;
- Investors' expectations with respect to the rate of inflation;
- Currency exchange rates;
- Interest rates;
- Investment and trading activities of hedge funds and commodity funds; and
- Global or regional political, economic or financial events and situations. Should there be an increase in the level of hedge activity of the precious metal held by the Trust or producing companies, it could cause a decline in world precious metal prices, adversely affecting the price of the shares.
Also, should the speculative community take a negative view towards the precious metal held by the Trust, it could cause a decline in prices, negatively impacting the price of the shares. There is a risk that part or all of the Trust's physical metal could be lost, damaged or stolen. Failure by the custodian or sub-custodian to exercise due care in the safekeeping of the metal held by the Trust could result in a loss to the Trust. The Trust will not insure its metal and shareholders cannot be assured that the custodian will maintain adequate insurance or any insurance with respect to the metal held by the custodian on behalf of the Trust. Consequently, a loss may be suffered with respect to the Trust's metal that is not covered by insurance.
Investors buy and sell shares on a secondary market (i.e., not directly from Trust). Only market makers or authorized participants' may trade directly with the Trust, typically in blocks of 50k to 100k shares.
Diversification does not eliminate the risk of experiencing investment losses.
Commodities generally are volatile and are not suitable for all investors. Carefully consider the Fund’s investment objectives, risk factors, and fees and expenses before investing. This material must be accompanied or preceded by a prospectus. Please read the prospectus carefully before investing.
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ALPS Distributors, Inc. and Aberdeen Standard Investments are not affiliated entities.
Prospectuses for Aberdeen Standard Physical Gold Shares ETF, Aberdeen Standard Physical Palladium Shares ETF, Aberdeen Standard Physical Platinum Shares ETF, Aberdeen Standard Physical Precious Metals Basket Shares ETF and Aberdeen Standard Physical Silver Shares ETF