Commodities in demand

• Commodity indexes have rallied amid heightened geopolitical uncertainty and structural supply shortages
• Commodities have historically shown resiliency in rising rate environments and can help investors hedge against rising inflation and diversify portfolios
• Commodity exchange traded funds (ETFs) offer convenient and affordable access to a broad range of commodities

Heightened geopolitical and inflationary pressures this year have put a spotlight on commodities, with investors using the asset class for a dual purpose: a potential hedge against inflation and adding diversification to a broader portfolio in a rising rate environment. As a result, we’ve seen an increase in prices and volatility across the commodity asset class as a whole.

Commodities, as represented by the S&P GSCI — a benchmark of 24 commodities in agriculture, energy and metals — is one of the top-performing asset classes year to date, up 34.52% through March 22^nd, outpacing all other asset classes¹.

Structural drivers - such as strong demand from economies reopening from COVID-19 restrictions, localization of supply chains, and historical under-investment in commodity production — mean that the supply and demand mismatch could persist. Meanwhile, heightened geopolitical risk may be supportive of continued commodity strength. The current disruption in energy and commodity supplies could impact the inflation outlook significantly. 40% of Europe’s natural gas is sourced from Russia; the country is also responsible for 43% of global palladium, while Russia and Ukraine combined account for nearly 30% of global wheat exports.²

We see specific themes in commodities that could benefit from the transition to a low carbon economy.  For example, we see persistent demand due to the vital role commodities play in renewable technologies, specifically metals such as copper, nickel, and aluminum. Copper, in particular, will be key to the low carbon transition. The metal is highly conductive and malleable. On average, a battery electric vehicle uses 183 lbs. of copper versus only 18-49 lbs. required by an average internal combustion vehicle.³

We believe exposure to commodities could help hedge against inflation. Notably, commodities like crude oil and natural gas are components within the energy portion of the Consumer Price Index, which measures inflation. Not only does energy make up 7.4% of this inflation gauge, but it also impacts the costs many businesses bear in producing goods and services in the economy.

On average, since 1997, commodities have historically outperformed the S&P 500 in the first 12 months after the beginning of a rate hiking cycle.⁵ They have exhibited relatively low correlation to equities and bonds over time, adding diversification to multi-asset portfolios⁶. Moreover, commodity sectors typically have a low correlation to each other. For instance, precious metals and livestock are two commodities sectors that have been negatively correlated in the last 10 years⁷. Therefore, broad commodity exposures could provide a source of diversification against equity and bond volatility within a rising environment.

We are seeing sentiment towards gold strengthening as geopolitical uncertainty continues. Gold’s low-to-negative correlation to equities has been sought as equity volatility has increased in recent weeks.⁸ We believe the precious metal could benefit in the case of a negative growth shock — an economic shock that decreases potential GDP caused by the rising commodity prices. A negative growth shock could slow central bank appetite for rate hikes, decreasing the opportunity cost of holding gold in portfolios.

Investors are increasingly using commodities in their portfolios for diversification of returns and to help mitigate other risks in their portfolios, like inflation. Demand for broad, diversified commodities ETFs that give investors access to commodity exposures across the energy, metals, agriculture, and livestock sectors has continued to increase in 2022, bringing in $6 billion YTD after $8.4 billion in 2021⁹. Gold focused ETFs also saw more than $9 billion of inflows as investors seek portfolio resilience.

Commodity ETFs offer convenient, affordable access to broad commodities exposures and can help investors align their portfolios with their views on inflation and economic outlook.