Torsten Asmus
By Hakan Kaya, PhD
A laggard over the past decade, commodities appear, in our view, poised for continued strength in the years ahead.
Stocks and bonds have been highly correlated to each other this year, forcing many investors to look for new alternatives to traditional financial assets that could have more potential strength in the face of inflation. Despite recent weakness, we believe that commodities could be very appealing in this regard, both for insulation against inflation and total return prospects.
According to our “regime” approach to inflation, the period when you most want to avoid commodities is in a deflationary bust – like in the 1929 Great Depression, when there was a premium on relatively safe assets such as cash or bonds.
Then there’s the disinflationary boom experienced over much of the past 30 years when globalization and productivity gains contributed to low inflation. During that regime, simply holding onto equities or a balanced 60/40 stock/bond portfolio was generally effective.
However, the reintroduction of inflation has created new complications – and opportunities. The inflationary boom we saw last year, combining high inflation and growth, provided an environment where equities did well, but typically not as well as commodities, while inflation cut into those equity returns.
Finally, there’s the inflationary bust, of which the 1970s are a prototypical example. In that case, reinforced by the OPEC embargo, inflation proved persistent. In such a regime, financial assets generally have suffered losses, while commodities have thrived. We believe the current environment most resembles this sort of scenario.
Supply/Demand Inflection Point
In our view, we are likely headed into an inflationary regime in which commodities could be supported by major shifts in supply and demand that could last for years. On the supply side, little money is going into the commodity markets, while those who do invest are generally focusing on cash-flow safety rather than growth. This, along with environmental worries, is helping to limit production across energy, mining, and agriculture.
On the demand side, businesses and politicians have made choices that are supportive of commodity demand: Deglobalization has accelerated given the pandemic and geopolitical conflicts; the green transition is creating supply issues across the fossil fuel space, creating extreme scarcity and demand for the base, battery, and some precious metals; and increased social spending is likely to help to maintain demand even at elevated prices.
In our view, the current trends around commodities are long-term and global. Maintaining exposure to the asset class may be crucial for investors over time.
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