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Can commodities sustain their rally?

This article is part of
Multi-Asset Investing - June 2016

Can commodities sustain their rally?

Commodities, along with emerging markets, have been out of favour with investors for some time, but the first half of 2016 has seen a change in fortune for the asset class, with gold and oil seeing prices improve.

Figures from the World Gold Council show the gold price rallied 17 per cent in the first quarter of the year in dollar terms, its best performance in almost three decades, while demand for the precious metal increased 21 per cent year on year, according to the organisation.

TD Direct Investing has also recorded a 24 per cent increase in the number of customers investing in gold in the past four months.

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Michelle McGrade, chief investment officer at TD Direct Investing, notes: “Gold is often considered a hedge and a ‘safe haven’ investment when stockmarkets are volatile or when there is wider economic uncertainty. The rally of the past four months links back to this need for security, coupled with the fact that more experienced investors will trade into the price fluctuations – and so must believe the price will continue to rise.”

But David Coombs, head of multi-asset investments for Rathbone Unit Trust Management, questions how much of a hedge against inflation gold actually is, noting that while it is a very good ‘hyperinflation’ hedge, when inflation is in double digits, “it’s not really a good hedge for the normal inflationary cycle”.

He adds: “Gold, like any commodity, has no earnings stream so there is a higher risk. Without that income stream, the asset is likely to be more volatile. That’s not a bad thing if the correlation is in your favour. The problem is the correlation of gold changes all the time.”

For example, Mr Coombs points out it tends to have a negative correlation with the dollar owing to the interest rate cycle, so typically rising US interest rates are negative for gold.

Christopher Mahon, director of asset allocation research at Baring Asset Management, notes: “Precious metals such as gold and silver have been the clear winners in our portfolios this year. Yet from here with interest rate rises on the cards, the best returns are now behind them.”

Meanwhile, oil has also enjoyed a rebound with the price of Brent Crude breaking the $50 a barrel mark at the end of May, compared with the low of $27 a barrel in January.

Adrian Lowcock, head of investing at Axa Wealth, notes that supply has fallen more quickly than anticipated largely because of “uncontrollable and unpredictable events as wildfires in Canada cut production by about 1m barrels a day and militant action in Nigeria also affected supply there”.

He adds: “The price of Brent crude is up about 80 per cent from its January lows and the outlook for the price has improved. However, supply issues remain because Iran has been increasing production while Saudi Arabia has indicated it might raise production further in 2016. As the price rises, oil producers will begin to bring rigs back online, adding more supply. Given this outlook, the oil price is expected to stabilise at about the $50 mark for the rest of the year.”