After doubling since the Covid crash of 2020, commodity prices recently slipped 20% from their highs as investors began to worry more that a global recession might cut demand for raw materials. It makes this an ideal time, then, to bulk up on commodities. Here are three reasons why you should consider buying the dip and adding more commodities to your portfolio…
Commodities add muscle to your portfolio.
You’ve heard it time and time again (and with good reason): diversifying your portfolio is important, especially when the economic environment is uncertain. The problem with owning just stocks and bonds is that, to perform well, they both need inflation to be low. That’s because when inflation’s high, central banks tend to respond by raising interest rates. And those two factors – higher inflation and higher interest rates – diminish the “real” present value of the future cash flows of both asset classes. You’ve seen this all year long: with inflation high and the Federal Reserve raising rates, stocks and bonds have been struggling.
Thankfully, commodities address that blind spot in your portfolio. Commodities like oil, gas, metals and agricultural products thrive when inflation is high and interest rates are rising, like they’ve done all year. That’s partly because commodities are real assets with intrinsic value. But it’s also because they’re often at the heart of what’s driving inflation, since they are the raw element of almost everything produced. Put differently, when inflation’s rising, it’s probably because commodity prices are rising.
There’s no guarantee that inflation will remain high over the next few years, mind you. But there’s no guarantee that it’ll just fall back to its previous low levels either. That’s why adding a touch of commodities into your portfolio makes so much sense: it could give your portfolio a needed boost if both stocks and bonds continue to underperform.
They’re in low supply, and “backwardation yields” are tempting.
Years of underinvestment in production capacity, spiraling pandemic disruptions, and a war between Ukraine and Russia all pushed the supply of commodities to incredibly low levels. And with no quick solution in sight, the lack of inventories should put a floor under prices, as people rush to buy up commodities, fearing shortages or depletions.
Perhaps more importantly, this tight supply is forcing buyers to pay a premium if they want to secure delivery in the near future. That pushes the price of shorter-term contracts higher than those of longer-term ones, in a situation known as “backwardation”. And as we explained here, backwardation means that long-term commodity investors can buy commodities at a discount and earn an attractive extra return called the “backwardation yield”. This extra return means that commodity investors could earn attractive returns even if the price of the physical commodity doesn’t change much.
Everyone loves a long-term boom.
We’re likely seeing the start of a “commodities supercycle” –that is, a stretch of high prices and strong demand that typically lasts for over a decade. If decades of falling interest rates and inflation have boosted the attractiveness of financial assets (like stocks) over real assets (like commodities), the new era of rising interest rates and higher inflation is likely to push the pendulum in the other direction. As investors, governments, and companies turn their focus back to the “real economy” (things like infrastructure, manufacturing, and real estate), the demand for raw materials should surge, along with their prices.
Meeting all that demand won’t happen right away. Years of low prices and regulatory pressures have chipped away at production investment and output rates. So it could take years for supply to meet a rising demand –and that’ll keep pushing prices higher in the meantime.
So what’s the opportunity?
About a year and a half ago, I made the case for bulking up on commodities and slimming down on stocks, and since then, commodities have gained 78% while stocks have only returned 7%. And even after such a strong run, I still believe that commodities have an attractive risk-reward profile at these levels. Sure, there are risks in the short-term: a global recession that could seriously dent the demand for commodities, for example, or a badly needed solution to the energy crisis in Europe. But for those wanting to build a balanced long-term portfolio, owning commodities is a must, and today’s dip presents an attractive entry point.
There are lots of ways to invest in commodities, but one of the best ways is the abrdn Bloomberg All Commodity Strategy K-1 Free ETF (ticker: BCI, expense ratio: 0.25%). It’s the cheapest liquid ETF, and it’s well diversified. For European investors, the L&G All Commodities UCITS ETF (BCOG) is a good bet: it tracks the Bloomberg Commodity Index and provides you with a diversified exposure to energy, precious metals, industrial metals, livestock, grains, and soft commodities. The extremely low expense ratio of 0.16% makes it a highly efficient way to bet on commodities.
