Content provided by Grant Engelbart, CFA – CLS Portfolio Manager
Not surprisingly, commodities have been one of the worst performing asset classes over the past several years. Headline grabbers such as oil and gold have lost their respective luster, and others have followed suit. A combination of factors has driven prices lower, most recently the strong U.S. dollar (the dollar and commodities have historically had a strong negative correlation). Slowing global demand, particularly out of China, and supply-side advancements in energy commodities in North America have also contributed. The wild ride investors have ridden in commodities has been enough to upset the stomachs of most. So, are commodities even worth owning?
Commodities in a portfolio of traditional assets (stocks and bonds) have historically had a number of benefits. First, correlations have been low. Low correlations translate into a smoother ride for a portfolio over the long haul, even when adding a higher-volatility asset class such as commodities. Related to this, certain commodities such as gold and some agricultural commodities can be more defensive in nature. Commodities are also inflation fighters. When prices are rising, generally raw commodities (inputs) are also rising.
Does that mean there is value in commodities now? Commodities are notoriously difficult to value, as they have no cash flow or earnings. One method to value commodities is to look at their real (inflation-adjusted) price over the long haul, as shown in the chart below. Prices below average translate into higher future returns, and vice versa. After the recent slide in oil, it appears there may be some value in commodities. Certain segments, such as agriculture, are at even more attractive levels and have solid and sustainable demand – 7 billion mouths to feed and counting!
The Federal Reserve is expected to raise interest rates later this year. During periods of tightening (raising rates), commodities has been the best performing asset class, as explained here. In fact, during Fed tightening cycles since 1970, commodities have only fallen in one cycle. For this performance to repeat, we will likely need to see some signs of inflation picking up. Rising wages across major retailers such as Wal-Mart and Target is a good trend in that direction.
What will it take to resuscitate this apparently dying asset class? A strengthening global economy, slowdown in the dollar’s dramatic rise, and some further signs of inflation may help to revive commodities.
The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change. No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.
The graphs and charts contained in this work are for informational purposes only. No graph or chart should be regarded as a guide to investing.
Commodity instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargo, tariffs, and international economic, political, and regulatory developments. Valuation is the measurement of the current worth of an asset or company. There is no one single method to determine valuation.
The S&P GSCI (formerly the Goldman Sachs Commodity Index) serves as a benchmark for investment in the commodity markets and as a measure of commodity performance over time. It is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot invest directly in an index.