Commodities have been a very disappointing area to be invested over the past few years but they could be at the start of another “extraordinary” bull run, according to the team at Schroders. 
The S&P GSCI Commodity Spot price dropped in the four consecutive years from 2012 to 2015 by 4.14, 4.03, 29.76 and 21.15 per cent respectively.
Gavin Ralston, head of official institutions, said: “Commodities have been a very disappointing place to invest for some time.
“The return on the broad commodities indices was negative and that was of course at a time when equities and bonds were giving pretty strong inflation-adjusted returns.”
However, he added: “We’ve seen a bit of a flurry in commodities this year, the indices are up 7 or 8 per cent so far this year but nothing to repair the damage that was done in the previous years.”
Performance of index over 5yrs
Source: FE Analytics
So far in 2016 the S&P GSCI Commodity Spot index is up some 40.47 per cent, but remains 27.93 per cent lower than it was five years ago, as the above graph shows.
Geoff Blanning, Schroders’ head of emerging market debt and commodities, said: “Commodities have gone down and down in the last five years up until this year with many losing 75 to 80 per cent in price in that period which was a really quite extraordinary bear market.
“A number of those commodities have bounced this year – we probably have 10 commodities that are up 25 per cent some a bit more – but that’s a pretty modest bounce compared to where we’ve come from.
“We’re still a long way from the highs – and that doesn’t mean we’re going to go straight back there – but what happens in a major bear market is that supply and demand dynamics change as the prices fall.
“We said at the start of this year that commodity bear market is over. We think we have started a new bull market. We are going to see a bull market that will go on for years and could potentially be an extraordinary market.”
Matthew Michael, product manager of emerging market debt, currencies and commodities says people are “woefully underinvested in real assets – I think that’s fair to assume” and as a result should look to up their exposure to those with the highest upside.
He suggest gas, which many “ignore, tending to focus mostly on oil,” as an option investors should look at in the current climate.
“Gas is really important especially if you are based in Europe and what we’ve seen is a stalling gas production and it isn’t a surprise given the fact that prices went from over 12btu to at one point below 2btu – that’s a huge decline,” he said.
While some producers have been able to continue to operate at current levels, due to a number of strategies including cost-cutting and hedging strategies, there has been no growth in gas production since the start of 2015, as the below graph shows.
Performance of US natural gas supply vs price
Source: Schroders
“You can see why – the price has collapsed – but now the price has started to go up,” Michael said. The natural gas price has risen 57.35 per cent year-to-date, having fallen 14.43 per cent in 2015 and 27.45 per cent in 2014 and remains 41 per cent lower over the last decade.
However, the big question is what’s going to happen to demand “because if you’re not increasing supply that’s not a problem if demand is flat”.
“Demand for natural gas is booming. If you were ever looking for a commodity where the supply and demand balance was very clear it doesn’t get much clearer than this,” he said.
Looking particularly at US electricity supply, there has been a shift in recent years.
“If we were having this conversation 15 years ago about 55 per cent of US electric generation came from coal and just over 10 per cent from gas,” Michael said.
“That’s now crossing and its partly down to the fact gas is cheap, it’s in abundance thanks to shale meaning it has become quite low cost to extract and its perceived to be green.”
Therefore, there is a situation where supply is stagnant, with no growth for almost two years as producers have “simply no incentive to do that because the return on capital is too low”, with steadily rising demand.
“So natural gas is probably one of those markets where you would want to start looking for investments,” Michael said.
The other area he suggests investors should look at is base metals, particularly nickel, which has seen its spot price rise 53 per cent so far in 2016, having fallen 38.40 per cent last year.
Performance of index over 10yrs
Source: FE Analytics
Over the last decade the metal has lost 44.66 per cent of its value, suggesting there is still some way to go to reach the highs seen before the financial crisis in 2008.
Part of this optimism has been centred on expected fiscal stimulus packages in the US and UK, with the chancellor Phillip Hammond announcing yesterday new infrastructure packages, while president-elect Donald Trump has pledged a number of infrastructure projects.
However, Michael said: “We’re not really going to count too much on that because a lot of these events are very difficult to plan for and will be long term in terms of timeline.
“But what we know is that the price of something like nickel has gone from $60,000 per tonne to about $10,000 per tonne. The decline has been very dramatic.
“What does that mean if you are a producer – most are losing money, so you can’t keep on producing something at a loss, eventually you have to do something about your supply.
“And that’s what we think is going to happen over the next year or so. Already the price has started to react.”