After being in the doldrums for years, broad commodities are back – with a bang. The ongoing bull rally has triggered murmurs of a potential commodities supercycle. Investors who are excited by the ‘s’ word probably have a long time horizon, i.e., they are thinking strategically rather than tactically. If this is the case, diversity is among the key principles they are likely to consider.

Diversity, when it comes to constructing portfolios, is typically achieved by adding asset classes with relatively low correlation to the usual suspects of asset allocation, i.e., equities and bonds. But dissecting the sources of this diversity can help investors see how commodities can add value. Upon doing so, three key dimensions become apparent.

The defensive

Commodities are often touted as effective downside hedges, i.e., they do better when equities pull back sharply. This property is achieved because broad commodity baskets include so-called ‘safe-haven’ assets like gold.

But portfolios also need defending on the upside, especially when inflation starts to rise. While broad commodity baskets offer a natural hedge against rising prices, gold has historically provided effective protection in periods of particularly high inflation (such as the 1970s).

The cyclical

During an economic upswing, aggregate demand from consumers, businesses, and governments rises. There is greater need for resources like energy and industrial metals. Holding broad commodity baskets allows investors to participate in this growth phase of the economic cycle.

Agricultural commodities provide a different type of cyclicality given weather patterns and seasonal demand and supply can determine prices. As these forces are unrelated to the drivers of equities and bonds, the correlation of agricultural commodities with those asset classes also tends to be low.

The thematic

Due to their growing use in emerging technologies such as 5G, electric vehicles, and renewable energy, metals are increasingly being seen as thematic investments. For example, copper’s use in passenger electric vehicles is forecast to rise from less than 0.5 million tonnes (Mt) in 2020 to over 2.5Mt by 20351. Other metals including nickel, aluminium, tin, and silver, among others, are all expected to play unique roles in the theme. These themes could fuel sustained growth in demand for industrial metals in the future.

Investors can, therefore, diversify across three distinct dimensions by adding broad commodities to their portfolios. The decision making doesn’t end there though as there are myriad ways of accessing commodity investing – something investors should also carefully consider.

Source: Wood Mackenzie 2019 forecasts.

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