We previously wrote about 2022 being a double whammy for investors as both stocks and bonds posted negative years—something that doesn’t happen often. However, there was one asset class that enjoyed a stellar year of returns.
Commodities posted a double-digit positive return in 2022 even while stocks and bonds both had double-digit negative returns. The Bloomberg Commodity Index was up 16.09% in 2022 after increasing 27.11% the year prior.
Commodities-related stocks (companies that do business in commodities) also benefited last year. Energy companies saw huge profits as the price of oil averaged over $90/barrel in 2022. The Energy Select SPDR Fund (XLE) gained 64%, easily the best performing sector of the S&P 500.
Fortunately, we recognized inflationary pressures after COVID government policies and were able to add commodities to client portfolios starting in 2021. Additionally, a host of issues caused us to overweight energy companies at the same time.
This was a win for our clients as we were able to profit off the global rise in raw materials. This helped to offset losses elsewhere and was a silver lining during a tough year.
Why did we invest in commodities?
Commodities are an investable asset class distinct from stocks and bonds. But we aren’t trading physical barrels of oil or bushels of wheat. Commodities trade in the futures markets. Futures allow investors to buy or sell a commodity at a specific price in the future without ever having to touch a physical commodity.
A diversified basket of commodities futures can be bought through a mutual fund or an ETF (electronic funds transfer), so it’s easy to insert into a portfolio.
We invested in commodities for two reasons. First, global supply of many commodities was tight. Spot prices (the current price of a commodity) of many commodities were higher than prices in the future, meaning the market was undersupplied. This also generates a positive “roll yield” that is collected by investors.
Second, a Russian invasion of Ukraine was rumored. Both countries are important commodity producers, and a war would likely disrupt supplies of crude oil, natural gas, and wheat. The war did occur, and commodity prices skyrocketed in the early part of 2022, therefore the addition of commodities to our portfolios was timely.
But is it likely to continue?
Commodities tend to be cyclical. There are booms followed by busts. A commodity “super cycle” occurs when prices move above their long-term trends. A surge in demand is not met by an increase in supply, and prices must rise above trend until demand is destroyed by high prices or more supply is brought to market. The two most recent commodity super cycles occurred in the 1970’s and in the 2000’s until the Great Financial Crisis.
Could we be in one of these super cycles now? Possibly.
In addition to growing demand for oil and gas, the world is trying to transition to green energy. This increases demand for industrial metals such as copper, aluminum, lithium, and cobalt. The demand is likely to be there.
What about supply? The real commodity story could be the underinvestment in supply since the last super cycle. After 2008, low prices discouraged capital from flowing to natural resource companies such as drillers and miners. A decade of poor returns has kept money away and it has found its way to companies in newer sectors like technology.
Because of this underinvestment, we are more likely to see periods of commodity price pressures in the future.
Stocks, bonds, AND commodities
From my personal experience, commodities are underutilized by investors. Why?
One reason commodities aren’t popular is a lack of understanding. Commodities are different from stocks and bonds. How does an investor profit off oil, orange juice, or copper?
The main reason I think investors neglect commodities is poor returns. As stated, commodities boom and then bust. We are coming out of a decade of poor returns, and investors love picking recent winners.
But there are three asset classes, not two: stocks, bonds, AND commodities! I believe there are opportunities in all three, just as past cycles have shown.
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