History Rhymes or 5 Arguments for Investing in Commodities
I have always considered commodities to be very “trendy” markets. They tend to make large moves up and down, often lacking the fundamental basis behind the swings.
After nearly a decade of underperforming almost every asset class on the planet, commodities markets could well be heading for the resurrection.
There are about 50 major commodity markets worldwide that facilitate investment trade in approximately 100 primary commodities.
I often revisit the historical chart of the Bloomberg Commodity Index, to check on the range and trend. This index tracks more than 20 commodities in energy, agricultural and precious metals and it basically represents the commodities markets in general.
So what’s the current trend? For anyone with common sense, it’s beyond doubt that the commodities are an underperforming asset class. The benchmark has fallen more than 55% from its 2011 peak as investors have been avoiding the asset class.
And the best part is that commodities have intrinsic value, generally speaking, you can assume their prices will not fall to zero. Therefore, when certain commodities reach technical lows, I see a tremendous buying opportunity.
This “trend-following” strategy will do very well, especially if I put it in perspective with the performance of the rest of the financial markets. Just look at what happened in stocks and bonds. Stocks have been steadily rising for the past 10 years and bonds for 8 years. And on top of that, both are at their all-time highs. I’ve been trading stocks and commodities for 25 years and in my humble opinion, commodities seem slightly undervalued in comparison.
Mark Twain once said: “History doesn’t always repeat itself, but it often rhymes.” Economists have already backed this effect with something called “theory of the commodity “supercycle,” a term coined during the 1990–2008 period when most commodities experienced double-digit annual price growth.
Take the price of oil and copper for example. They rose by 1,062% and 487% respectively during the so-called ‘supercycle’ period as sudden demand from emerging markets in Europe and Asia surged after years of stagnation.
Amazing, isn’t it? I doubt that this time the gains will be as extreme as 20 years ago, but the rhyming rationale is still sound.
Right now, there are lots of arguments for buying commodities, but let me break this down to five:
- Hedge against event risk
There is barely any lack of turmoil in global affairs, and it’s almost certain that geopolitical events are going to dominate the markets in the near future as well. If we add natural disasters, economic crises, trade wars, market glitches, and black swans, we can safely proclaim that the only certainty is uncertainty. It all boils down to this, the event risk affects equities and bonds negatively, but commodities thrive in such an environment and may act as a potential hedge.
2. Diversification — zig when stocks zag
Commodity returns are usually inversely proportional to the returns of both stocks and bonds. So often, when other major asset classes fall, commodities rise. But there is a catch, this inverse relationship is not perfect. If the world economies were to slow sharply, commodities would definitely experience a steep fall. Just look at what happened during the 2007–09 recession in the US, commodities dropped 40%, which was a deeper downturn than stocks.
Compared to other asset classes like real estate, commodities trading is very much liquid. You can trade them as spot in physical form, in the paper as futures, ETFs or CFDs, and in crypto form as synthetic assets. The result? It is easy to buy and sell a commodity and you can liquidate your position whenever required.
4. Protection against Inflation
Commodities are directly proportional to the corporate debt which means that it will move with debt. The US government’s debt has reached 108% of GDP and other developed countries are no better. Here is what I mean. Money-printing usually results in inflation and commodities are one of the few asset classes that benefit from inflation. Having few commodities in your portfolio will definitely help you to beat the market.
5. Potential for more returns
And on top of all that, there is my favorite “trend-following” argument. How does this work? You can take advantage of the volatility to earn huge profits. Just look at the chart above and you realize that this might be the best timing for creating a commodity portfolio.
The bottom line is that after long years of underperformance and cumulative losses totaling over 50%, the resurrection of tangible assets is imminent. And it is often when sentiment is close to rock bottom that I reassess a potential investment.
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Originally published at https://medium.com on August 5, 2019.