The commodity asset class finished 2017 in positive territory, capping off two years of growth for the mainstream indices. Given the negative returns over the prior five years, though, this asset class still has a way to go before investors embrace it.
What will 2018 bring? Well, the current state of the economy may very well be setting up for continued strength in the commodity asset class. And given how out-of-favor the asset class has become, now may be just the time to get back in.
Commodities are Attractively Valued
Simply put, commodities look cheap. And not just on an absolute basis. When compared to the bull markets experienced in stocks and bonds since the 2009 financial crisis, commodities appear to be a bargain. These opportunities don’t last forever, though. Given their current cheapness, now may be a great time to invest in commodities.
Commodities relative value versus stocks and bonds, 2/28/2009 – 12/31/2017
Source: Bloomberg, Parametric
Commodities represented by the S&P GSCI™ Total Return Index. Stocks represented by the Russell 3000® Total Return Index. Bonds represented by ICE BofAML U.S. Corporate Index.
Current Stage of Economic Cycle Favors CommoditiesWe are currently a little more than 8½ years into the expansion phase of the present business cycle, which makes it one of the longest on record. Given the length of time since the last recession, it is very likely that we are in the later stages of growth, which is when commodities typically begin to outperform. If that is the case, commodities are well positioned to see a rally this year.
Average monthly return for commodities over the past six economic cycles favors a late-stage rally by this asset class
Source: NBER, Bloomberg, Parametric
Commodities represented by the S&P GSCI Total Return Index.
Dollar Weakness Supports CommoditiesThe U.S. dollar and commodity markets have historically displayed a negative association. As the dollar weakens against other major currencies, commodity prices tend to increase and vice versa. One explanation is that when the dollar depreciates, goods that are priced in dollars become less expensive to global users, causing demand to rise. The reverse is also true when the dollar appreciates.
S&P GSCI Total Return Index vs U.S. Dollar Index, 12/31/2010 – 12/31/2017
Source: Bloomberg, Parametric
In 2017, the U.S. dollar fell nearly 10% versus a basket of six developed currencies and, according to economists at the Institute of International Finance, it may have another 10% to go before it reaches a “fair” level with respect to the U.S. trade deficit. If that is the case, what has been a steady headwind to commodity performance over the past few years may very well turn into a tailwind.
The commodity asset class enters 2018 wildly out-of-favor after underperforming most other mainstream asset classes for several years. But don’t count commodities out just yet. If the U.S. economy has any influence, commodity prices may very well exit the year on a high note.
Greg Liebl, CFA - Portfolio Manager
Mr. Liebl is responsible for all Parametric proprietary and non-discretionary commodity strategies in the Minneapolis Investment Center. Since joining Parametric in 2010*, Greg has provided Portfolio Management in the areas of risk and exposure management and customized implementation solutions.
*Reflects the year employee was hired by The Clifton Group, which was acquired by Parametric Portfolio Associates® LLC on December 31, 2012.
Investing in a commodities strategy involves risk and may not be suitable for all investors. The value of commodities investments will generally be affected by overall market movements and factors specific to a particular industry or commodity, which may include weather, embargoes, tariffs, health, and political and international and regulatory developments. Economic events and other events (whether real or perceived) can reduce the demand for commodities, which may reduce market prices and cause their value to fall. Derivative strategies also have certain disadvantages and risks. Futures require the posting of initial and variation margin. Therefore, a portion of risk capital must be preserved for this purpose rather than being allocated to a manager. The use of derivatives can lead to losses or adverse movements in the price or value of the asset, index, rate or instrument underlying a derivative due to failure of a counterparty or due to tax or regulatory constraints.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.