Close Close
ThinkAdvisor
The risks of stagflation are rising.

Portfolio > Alternative Investments > Commodities

Inflation Predictions Are Boosting Interest in This Asset Class

By John Manganaro

X
Your article was successfully shared with the contacts you provided.

What You Need to Know

  • While 2010 to 2020 proved challenging for commodities, higher inflation in the 2020s could bolster performance.
  • Another reason for commodities optimism is the ongoing global transition towards a greener economy.
  • For long-term investors, commodities and equities can diversify each other well, especially across different market cycles.

Due to their sub-par performance during the 2010s, many advisors have turned away from commodities in favor of higher concentrations in U.S. and global equities. That playbook served many investors well, thanks to the incredible run that equities enjoyed during the decade.

But according to experts with the specialty exchange-traded fund provider USCF Investments and index developer SummerHaven Index Management, the outlook for the rest of the 2020s is much different.

In fact, as SummerHaven Index Management CEO Kurt Nelson argued during a recent webinar hosted by USCF Investments, there’s good reason to believe the inflationary pressures affecting the global economy could push commodities back into the spotlight in the years ahead. Another reason for commodities optimism, Nelson suggests, is the ongoing global transition towards a greener economy.

During the discussion, Nelson acknowledged that individual commodity categories are often viewed with hesitancy by investment professionals building portfolios for their clients, and perhaps rightly so.

However, investing in well-constructed and well-diversified commodities funds as part of a holistic investment strategy that also includes traditional equities and bonds can be a winning strategy, Nelson argues, especially from a risk-adjusted perspective.

In the end, Nelson says, advisors and investors should take some time in the present moment to reassess their perspective on the role of commodities, arguing that the 2020s are likelier to resemble the 2000s than they are to resemble the 2010s.

If that comes to pass, Nelson suggests, diversified commodities funds could deliver impressive results, even during a decade defined by inflationary pressures and weaker global economic growth.

Inflation’s Recent Past

As Nelson recalled during the webinar, during the 2010s, the U.S. and global markets enjoyed many subsequent years of steady, accommodative monetary policy, as well as significant fiscal policy support from governments across the globe.

Despite this, inflation continued to run well below the Federal Reserve’s 2% target, and there was more concern about reaching full employment than there was about the potential for inflation to spiral out of control. During the middle of the decade, in fact, investors were more worried about deflation than inflation.

“This was a decade in which we were all operating in this zero-rate environment, and we all got pretty used to very low, almost non-existent inflation,” Nelson explains. “Well, as we all know, things have changed pretty dramatically coming out of the COVID pandemic. Now, in 2023, rates are back to what we would historically consider a normal range, and inflation is still elevated.”

Nelson notes that inflation has moderated from the “incredible levels” seen in 2022, when the consumer price index approached 10%, but the current level in the realm of 3% remains higher than the Fed’s stated target.

“This has all been a pretty big shock for many portfolios,” Nelson says.

Inflation and Commodities

According to Nelson, investors should accept the fact that the 2010s were an anomalous period that is not likely to repeat itself in the 2020s. That is, the massive amount of stimulus enacted in the wake of the pandemic, coupled with lasting supply chain disruptions, should be expected to drive elevated levels of inflation for the foreseeable future.

There’s  also an open question whether stocks can continue to far outstrip their long-term average return.

“We also have to be humble, however,” Nelson warns. “This is just a very uncertain environment, and that is why we are arguing so strongly for diversification into commodities. We are urging investors to accept this uncertainty and do what you they can to prepare, which is diversify the portfolio and right-size your risk-taking.”

As Nelson points out, during the 2010s, investors enjoyed roughly 14% returns per annum in their equity portfolios.

“That’s twice the long-run risk premium we expect from equities over long periods of time,” Nelson says. “It was just extraordinary, and it’s no surprise that, during that time, commodities underperformed. That, in turn, led to lower allocations.”

However, as Nelson emphasizes, it is easy to forget that essentially the opposite scenario played out between 2000 and 2010, when commodities delivered very strong performance relative to equities, which were essentially flat.

“So, if you step back and look at the prior 20 years, we saw commodities and equities diversify each other really well, and overall they have had relatively similar performance,” Nelson says.

Benefits of Low Correlation

According to Nelson, some individual categories of commodities have been performing well since the COVID crisis, but the “real winner” has been diversified commodities funds.

“This is common, historically, when inflation is high and rising,” Nelson says. “An interesting feature that has benefitted diversified commodities is that, within the category, there is a low degree of correlation in these types of environments.”

Beyond these historical lessons, Nelson says, there are reasons to be optimistic about various commodities categories moving forward. For example, broad global investment into green technologies and battery tech should bolster precious metals.

“The best performance will come from targeting commodities that are in critical supply shortages, not just taking the same old approach, because commodities in full supply do not tend to do as well,” Nelson explains.

Credit: Shutterstock 

John Manganaro

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.