The five-year run of heavy losses in commodities looks like it could have ended, according to Schroder’s head of commodities Geoff Blanning, who believes that the asset class’ next bull market has already started.
Few investors could have missed the plunging commodity prices that have acted as a backdrop to global economies and markets over recent years: FE Analytics shows the S&P GSCI Commodity Spot index fell 47.60 per cent over the five years to the end of 2015.
Performance of indices between 1 Jan 2011 and 31 Dec 2015
Source: FE Analytics
As the graph shows, losses have been almost across the board (aside from live cattle and cocoa, which made double-digit gains).
Brent crude oil held its own for the first three-and-a-half years but sold off heavily during the summer of 2014 and the following year, while falls in some cases – such as wheat and nickel – have been more than 60 per cent.
Blanning said: “Following five years of devastatingly poor returns in the market, sentiment towards commodities is at rock bottom, but it’s starting to turn following the surge in the prices of a wide variety of products since the beginning of the year.”
“The biggest price gains, in percentage terms, occur at the beginning of a bull market. And the best (lowest risk) time to buy anything is when the consensus expectation is turning from bearish to bullish, as is happening now in commodities. Now is the time for investors to focus on this unloved asset class.”
The below graph shows the extent of many commodities’ bounce back since the start of 2016 - the S&P GSCI Commodity Spot index, for example, is up 20.53 per cent while Brent crude has gone even higher.
Performance of indices over 2016 to date
Source: FE Analytics
While arguing for a return to commodities, Blanning adds that the primary reason for investing in the asset class “should always be as an inflation hedge”.
However, he suggests that continued loose monetary policy by the world’s central banks means that inflation could be on the cards – and the recent sharp rise in commodity prices may be “a warning sign that perhaps the inflationary times have begun”.
In his view, there are three main reasons why the rally in the asset class could continue.
Firstly, the over-supply that contributed to the initial price falls seems to be reversing. Blanning argues that the situation today is “quite different” to the credit-fuelled overproduction that followed the previous price boom; in the oil market, for example, many producers are going bankrupt and cheaper prices mean that production is being scaled back rather than expanded.
Secondly, the strong rise in the dollar that took place between 2011 and 2015 was one of the main reasons for weak commodity prices as they became more expensive as the currency surged. This dynamic has also started to reverse, with the dollar weakening.
“Of course, the dollar could start to strengthen again, especially if the Federal Reserve (Fed) starts tightening monetary policy more sharply,” Blanning argues.
“Historically, however, taking gold as an example, Fed tightening cycles have more often than not been unable to reverse the depreciating dollar trend or the rising commodity price trend (which is the main catalyst for tighter policy in the first place).”
Performance of gold during the Fed’s last tightening cycle
Source: FE Analytics
Finally, while the China-driven commodity boom appears to have stalled, the expert points out that demand is rising at a rapid pace in India. The country’s demand for crude oil is growing at a much faster rate than China’s, while Indian demand for commodities including palm oil, sugar, rubber and natural gas is rising fast.
Other forecasters are expecting a rise in most commodity prices in the near term. Capital Economics expects Brent crude to oil to reach $55 a barrel by mid-2017 (from its current $48.90), copper to go to $5,750 a tonne (from $4,725) and gold to hit $1,375 per ounce (from $1,215), for example.
Blanning concluded: “We believe we have witnessed the turning point for commodities. At least a dozen commodities have gained more than 10 per cent this year and a number have gained over 30 per cent; clearly, the bear market is over.”
“Commodities are under-owned and under-researched. The relentless selling that has been seen in recent years has eased, but few investors have started to buy; the majority are extremely nervous.”
“Nothing goes up in a straight line, and not every commodity will have yet seen a bottom. After some strong gains, it is normal to see corrections – which may be occurring for some (e.g. gold) right now. And the poor outlook for China is still a major question for many industrial commodities such as copper.”
“But in our view, when considering risk against potential return, the reasons to consider investing in a diversified, actively-managed commodity fund are as strong today as they are ever likely to be."
