Commodities deserve a place in any diversified portfolio, according to Trevor Greetham, manager of the Royal London global multi-asset portfolio range, but warns that the medium-term outlook for gold is troublesome.
This year has been a better year for commodities that previous history with the Bloomberg Commodity index rising sharply, having fallen heavily over a five-year period from 2010 to 2015.
As the below graph shows, commodities have outperformed equities and bonds so far this year, despite the well documented rise of both, in part due to the resurgence of gold and oil.
The commodities index has returned 32.37 per cent in 2016 in sterling terms, 3.47 percentage points ahead of global bonds and 7.67 percentage points above global equities.
Performance of indices in 2016
Source: FE Analytics
Invesco Perpetual chief economist John Greenwood said: “Three factors explain this outcome: stronger growth in Asia outside of China; some reduction in supply; and the fading of the effects of the strong US dollar.
“Together these have led to commodity price indices rising from their nadir in January 2016, but a positive outlook for commodities is by no means guaranteed.”
One area investors and analysts remain particularly unsure of is gold, with Greetham noting that the yellow metal tends to do well when the dollar is weak and when real interest rates are going negative.
“We’ve had a bit of that over the summer but recently the US data has firmed up again and that is why gold has sold off,” he said.
“It tends to well at the same time as your bonds are doing well because it tends to do well when interest rate real yields are dropping.”
Performance of indices over 10yrs
Source: FE Analytics
As the above graph shows, gold has broadly followed the pattern of bonds, steadily rising from 2009 to 2012 and rocketing higher in both 2008 and 2016, when bonds also performed strongly.
“They’re [interest rate real yields] at minus two, are they really going to minus five? I don’t think so. I think looking around the world real yields are mainly negative and gold has reflected that, but I’m not sure they are going to get more negative.
“I’d be concerned on a two to three-year view on gold because I think the US will be raising interest rates. The dollar will be strong and interest rates will rise so my medium-term view is negative on gold.”
However, according to GAM investment director John Lambert, silver could be the way to go within the commodity space, as it has a more industrial uses.
“Silver has outperformed gold this year, reversing many years of the opposite trend which had led to a historically stretched ratio where 1 ounce of gold could buy as many as 80 ounces of silver,” he said.
“Because the more significant industrial uses of silver make it more sensitive to economic activity, it typically takes the lead during reflationary upcycles in which both prices are rising.
“It now strongly appears that this key ratio has formed a new trend, confirming a more inflationary outlook.”
Overall, Greetham says multi asset managers should have commodity exposure, as it offers a multitude of potential winners in different markets.
“You have always got to be thinking ‘have you got a broad enough spectrum of asset classes so that something will be doing well in all circumstances’,” he said.
“When we built our range of funds earlier this year we wanted to make sure we included assets that offers some kind of resilience in a wide range of situations.”
Indeed, this year has been a bounce back year for commodities after falling dramatically from the highs seen in 2008 and the rally in 2010.
This prolonged sell-off since 2011 has been due to a number of factors, including fears that China is slowing down its infrastructure spending, as well as a general oversupply in the market.
However, a look at the life cycle of commodities since 2000 shows that they tend to perform well in bull markets, steadily rising from the end of the tech bubble in 2001 to the financial crisis in 2008, and then again from 2008 to 2010.
Performance of index since 2000
Source: FE Analytics
“If the world economy is strong and inflation is rising commodities are where you want to be,” Greetham said.
He adds that commodities “are usually doing well during stagflation periods as well so arguably there’s about half of the business cycle when commodities are the best place to be and most multi-asset funds don’t include [them]”.
“The real question is where we go from here and for us from a global stock market point of view there are still opportunities so we’re still in this not too hot, not too cold expansion which is generally good for equities,” he added.
“We think commodities are starting to look interesting as well with the growth in China so we definitely think there are some good opportunities out there still.”