Commodities had delivered outsized returns compared to most
other asset classes since the start of the millennium until the
financial crisis. Insatiable demand from China and other
emerging nations fuelled the unprecedented rally in commodities,
leading many analysts to call it a commodities "super-cycle".
Underperformance in the last couple of years, mainly due to
increased output and economic slowdown in emerging markets, left
investors wondering whether the commodities "super-cycle" was
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This year a combination of supply constraints and rising demand
seem to have resulted in brining commodities back in focus. Many
commodities have delivered stellar returns year-to-date and many
still look poised to outperform going forward as well. Here are
some strong reasons investors should look at commodities this
Declining Correlations = Better Portfolio
One of the reasons for investor interest in this asset class is
the recent decline in correlation with equities. Correlations had
spiked during the financial crisis and continued to be high after
that, leading investors to question the diversification benefits
Among the main reasons for rise in correlations were, rise in
inventories prior to crisis and predominance of risk-on/risk-off
trading subsequent to the massive monetary stimulus. (See:
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With the gradual withdrawal of QE and increase in volatility,
correlations have been on the decline for some time. Currently,
correlations of commodities to other asset classes are down to
pre crisis levels.
The 12 month
between the S&P 500 and S&P GSCI at 0.26 is lowest since
November 2008 and continues to head down further.
Backwardation Suggesting Higher Returns
Commodity investors need to understand the role of the structure
of futures curve in the return. Every month when future contracts
mature, fund managers need to sell the maturing contracts and buy
new contracts to replace them.
When the new contracts are more expensive then the maturing ones,
or in "contango", rollover results in losses. On the other hand,
if the new contracts are cheaper than the maturing ones, or in
"backwardation", the rollover results in positive returns.
Thus, investing in commodities via futures introduces the "roll
yield" and the return from underlying collaterals in total
returns calculations. (Read: 3
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According to Hermes Fund Mangers
for commodity investors is the best it has been in a decade due
to sustained broad backwardation seen in the last few months.
Usually backwardation indicates low inventories and supply
disruptions for the commodities and positive returns going
S&P DJ Indices
, 2013 was the first year commodities have been in backwardation
in a decade. During 1984-1991-the last long streak of
backwardation, S&P GSCI had positive returns every year
through 1990 for a total return of 221%.
Unusually Dry Weather Causing Supply Disruptions
Unusually dry weather in various grain growing regions in the
world has led to a sharp increase in the price of coffee, cocoa
and wheat this year. Arabica coffee has more than doubled in
price this year due to crop damage caused by drought in Brazil.
Beef saw its biggest monthly recently, mainly due to tight
supplies resulting from drought.
Additional many analysts predict that the "El Nino" may return
this year, pushing the prices for a number of commodities further
on the upward trajectory. El Nino causes weather disruptions in
many regions around the world, including drought in some and
flooding in others due to abnormal warming of the Pacific Ocean.
In particular, it is likely to impact sugar and rice crop in
India and wheat crops in Australia. Coffee, soybeans and cocoa
may also see supply disruptions.
Nickel prices--which are already surging this year due to import
restrictions in Indonesia--may spike from dry weather in the
Geopolitical Stress Pushing Prices Up
Heating up of tension between Russia and Ukraine, coupled with
potential trade sanctions on Russia, has caused turbulence in
commodity markets. Many investors sought refuge in gold as
violence in the region escalated.
Almost 40% of global supplies of platinum and palladium come from
Russia and fear of disruptions has supported these two precious
Russia is one of the largest producer and exporter of oil and
natural gas in the world and both Russia and Ukraine are major
wheat exporters. Ukraine is also an important producer of many
other grains too. Political unrest has pushed grain prices and
exports from the US up this year.
ETFs provide a convenient and low cost exposure to commodities.
Below are some ETFs that provide exposure to a broad basket of
United States Commodity Index Fund (
USCI tracks the price performance of portfolio of 14 commodity
futures, reformulated each month from 27 possible futures
contacts representing six sectors including metals, energy,
livestock and softs. The contracts are selected on the basis on
price performance including backwardation and are equally
PowerShares DB Agriculture Fund
Investors looking to benefit from surging food prices could
consider DBA that invests in widely traded agricultural
commodities through futures. Top futures holdings in the index
are corn, soybeans, sugar and live cattle-each with a 12.5%
GreenHaven Continuous Commodity Index Fund (
GCC invests in a basket of17 equal weighted commodity futures.
This ETF is a suitable option for investors who want reduced
impact of contango or backwardation. It employs a dynamic
Because of the equal weighting, GCC offers significant exposure
to grains, livestock, and soft commodities and a lower energy
weighting than many of its peers. In addition, GCC is rebalanced
every day in order to maintain each commodity's weight as close
to 1/17th of the total as possible.
Slowing growth in China and some other major emerging markets
will remain a concern for commodity investors. Investors also
need to remember that commodities are usually more volatile than
most other asset classes .
The Bottom Line
Commodities provide diversification benefits and as well as a
hedge against inflation. Further, various factors discussed above
suggest that a positive outlook for commodities this year. Thus
investors should consider a small allocation to commodities in
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PWRSH-DB AGRIC (DBA): ETF Research Reports
GRNHVN-CONT CMD (GCC): ETF Research Reports
US-COMMODITY IF (USCI): ETF Research Reports
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