Commodities: common materials, uncommon opportunities?

Investors often equate the risks of commodities investing with higher-risk alternative asset classes. However, investors should think of commodities as the basic yet vital ingredients in our daily lives — the raw materials needed for food, clothing and the energy that heats our homes.

Due in part to misconceptions, commodities have become a forgotten asset class in the last decade. Prices were rising at the start of the new millennium as the result of increasing industrialization in the emerging markets and concerns over availability of future supply. But this came crashing down during the 2008-09 Global Financial Crisis (GFC), as pressure on liquidity impacted almost every asset class and a credit crunch hurt industrial production. Since 2011, we have seen a slow, steady decline in broad commodity prices. We can attribute this to a confluence of events impacting the markets. These include higher relative interest rates in the U.S., a strong U.S. dollar and ongoing global trade tensions.

But despite what might seem a gloomy outlook for commodities, exposure to this asset class can help investors mitigate unforeseen macroeconomic risk, including surprise inflation risk. Today, there may be many reasons to invest in commodities.

Time-tested portfolio diversification

One of the main reasons we believe commodities are so attractive is their low correlation to other asset classes. This makes them conducive to portfolio diversification. If you compare commodities to major market indices over the last three decades, in general they have had little correlation. Some sectors have even had negative correlations. Moreover, while many investors think of energy or precious metals when they think of commodities, we find that many other commodity sectors — including livestock, industrial metals and agriculture — have had low correlations to the S&P 500, MSCI World and Barclays U.S. Aggregate indices.

Gold is a good example of a commodity that many investors misunderstand, often dismissing it as having an unattractive risk/return profile. But gold has had an average annual return over the last 20 years of more than 5.0%, with annualized volatility relatively low or in line with other asset classes. Many other individual commodities, including platinum, copper and soybeans, have also generated positive returns with relatively low volatility and little correlation to other commodities. So, the stigma that commodities are overly risky doesn’t hold up when you consider historical performance.

Preparing for inflation surprises and rising growth

“We are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes. However, inflation that is persistently too low can pose serious risks to the economy.”

U.S. Federal Reserve Chair Jerome Powell, August 27, 2020

As Chair Powell confirmed this summer, the U.S. Federal Reserve (Fed) now has a bias toward low and stable rates in addition to explicit tolerance for inflation overshoots to offset periods of low inflation. In our view, this, along with a maximum employment goal to partially offset income inequality, means that the Fed will remain dovish for the foreseeable future. And given the massive U.S. deficit, we believe that if the Fed wants to keep a lid on rates it will need to buy more U.S. Treasuries. This scenario would be negative for the dollar and — because commodities are priced in USD — may create a tailwind for commodities.

Taking accommodative monetary policy into consideration along with a weaker dollar, flattening yield curve and heightened volatility — as well as the likelihood for more fiscal stimulus — prices for commodities are compelling. We believe conditions could be ripe for a lift in prices sometime in the near future. In fact, if you look back at the dip commodities took in March as Covid-19 became more acute, prices were at a level not seen since 1999. As a result, it can be argued there is no other asset class currently as depressed.

Sector-by-sector outlook

Because commodities are not strongly correlated to each other and tend to be a collection of individual supply and demand stories, it’s important to look at individual sectors to better understand the broader commodities outlook. 

Energy. The low interest-rate policies post GFC spurred investment in new oil extraction technologies and helped attract capital to energy production, often times in uneconomic ways. The energy companies themselves were incentivized to grow production rather than profits. However, this trend is now in reverse. Companies are now focused on profit and free cash flow rather than growth. Several energy companies have announced acquisitions at zero premiums — an indication that the acquired company just wants to live to see another day. Energy production has significant depletion rates making them dependent on capital to continue stable supply levels. The renewable energy transition is a theme we like and invest in, however it is not hard to find estimates of electric vehicle penetration that are disconnected from reality. Automobile gasoline use is only 25% of global oil demand and unless we are banning petrochemicals, industry use, building use, shipping and aircraft use, we will need significant oil supply for at least the next 40 years.

Agriculture. A major drought event caused agriculture prices to spike in 2011-12 and subsequent years have seen a decline in prices that overshot below the cost to produce. A strong US dollar has higher negative consequences for some agriculture prices as countries like Egypt can purchase from a number of sources and just choose the cheapest after the effects of foreign exchange rates. Currently rather strong weather conditions have emerged which have affected planting in a number of global regions including the Matto Grosso region of Brazil where soybean plantings have been delayed. Additionally the strong dollar headwind for agriculture has shifted to a weak dollar tailwind for agriculture prices.

Precious metals. In our view, there have been three catalysts for gold demand in recent years:

  1. Global regulatory changes allowing central banks to significantly increase gold exposure
  2. Investor concern that fixed income will become a “return-less, risk asset”
  3. The potential for a return of retail purchasers in India and China during this year’s festival season

The outlook for palladium, an environmental metal used to reduce auto emissions, remains strong as regulations become even tighter. The outlook for the silver market, which may be buoyed by solar panel demand, also remains strong. While platinum is less talked about, hydrogen fuel cells depend on the metal and several countries and corporations are advancing this technology for heavy transportation solutions.   

Industrial metals. We believe that there will be no energy transition without industrial metals. We believe many investors do not appreciate the importance of industrial metals to energy transition (e.g., aluminum is needed for solar panel supports and for lighter electric vehicles, nickel is used in batteries, copper is used at 4 times the rate in an electric vehicle than an internal-combustion-engine vehicle). Our own analysis shows that even if electric vehicles are only 28% of yearly global sales an additional 4.2 billion pounds of copper would be needed each year- this does not account for additional charging infrastructure, electric grid upgrades necessary and additional generation capacity to charge the vehicles.  Leaving these metals out of environmental, social and governance portfolios is misguided.

Livestock. China’s bans on live cattle imports from the U.S., a result of mad cow disease in 2004, were lifted partially in 2017 and fully in 2020. The country recently started importing beef from Australia to meet demand. China also lost 50% of its hog herd to African Swine Flu which will take three-five years to replace. These are a few of the key factors for the strong outlook for livestock going forward.

Accessing the commodity markets

There are many ways to get exposure to commodities, but with each come unique complexities. We believe there are four important tenets investors should follow when seeking out commodity investments. First, look for products that provide historically low correlations to the equity and fixed income markets in order to gain the diversification benefits.

Second, seek out strategies built around transparent and rules-based benchmarks, such as the Bloomberg Commodity Index. In our view, this is the most effective way for investors to understand how their commodity investments align with broader investment goals. Third, consider cost, especially given that there are now more low-priced options than ever.

Finally, tax efficiency has been an issue for investors in the past because of the way commodity products gain exposure to underlying assets. Understanding how to mitigate the tax implications of commodity investments can go a long way to making investments in this asset class more rewarding.

Going forward: reconsidering commodities

For investors aiming to build portfolios resilient to short and long-term macroeconomic risks, these uncertain times have raised more questions than answers. However, we believe a fresh look at the role of commodities within portfolios can help cut through this uncertainty. We believe that the low correlation of the asset class to other investable assets and the current outlook for commodities in light of inflationary Fed policies and historically low valuations, may make today’s environment an ideal opportunity for investors to reevaluate their exposure to commodities, an asset class that remains indispensable in our everyday lives.



Aberdeen Standard Investments, Bloomberg. Data from 1 January 1991 - 30 September 2020. The S&P 500 Index is an unmanaged index considered representative of the US stock market. The MSCI World Index is an unmanaged index considered representative of stocks of developed countries. The index is computed using the net return, which withholds applicable taxes for non‐resident investors. The Barclays U.S. Aggregate Index is an unmanaged index considered representative of the US investment‐grade, fixed‐rate bond market.
Bloomberg, Aberdeen Standard Investments. Data from 31 December 1999 - 30 September 2020.
The Bloomberg Commodity Index reflects commodity futures price movements.

 

 

IMPORTANT INFORMATION

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.

Prospectuses:

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
Aberdeen Standard Physical Silver Shares ETF

ALPS Distributors, Inc. is the marketing agent.

ALPS Distributors, Inc. and Aberdeen Standard Investments are not affiliated entities

ETF001638 12/31/21

US-030321-144094-2

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

RISK WARNING

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.