Commodities can shine despite the recent setback for gold


by Chief Investment Office 12 Aug 2020

Thought of the day

Gold suffered its largest one-day decline in seven years, with a fall of 6% briefly taking it back below USD 1,900/oz after setting a record high only last week. But we expect the profit taking to be relatively short-lived, and gold is still one of the best-performing major assets of the year, up around 27%. And gold has not been the only commodity to rally in recent months. Broad commodity indexes are already up by around 7.4% in the third quarter, following a 12%–14% rise on a spot basis and a 5%–11% total return in the second quarter. Alongside strength in precious metals, including silver and platinum, base metals and energy have also gained ground.

We expect this broad commodity rally to continue, and forecast broadly diversified commodity indexes to appreciate by almost 15% over the next 12 months. This strength is likely to be based on several key factors:

  1. Commodities should benefit as the global economy improves. Based on our historical analysis, quarterly commodity returns tend to be higher when economic growth accelerates. In our analysis, they were more than double when the GDP of advanced economies gained speed during the full 30-plus year sample window. The key message here is that we should not wait until GDP growth in the developed world is back above trend to chase the asset class. That does not mean commodities don’t perform in the later stages of an economic cycle—they do perform strongly. But good returns can also be found when economic activity accelerates, even from negative territory.
  2. Supply constraints and low inventory levels are conducive for higher prices in several key commodities. Oil markets are a notable example. OPEC and its allies (OPEC+) have shown a great deal of unity. Global crude oil supply contracted to a 9-year low of nearly 87mbpd in June 2020. With discipline to keep the production cut deal expected to stay firm, as well as oil demand continuing to recover, oil inventories are starting to drop due to an undersupplied market. Beyond energy, we expect copper supply to drop this year by more than 3% due to the COVID-19 pandemic. This supply decline, mainly due to mining issues and a lack of copper scrap availability, could also trigger a smaller bounce in supply growth next year as new mine capacity is being pushed out. Finally, as economies reopen further, we anticipate a gradual recovery in demand for key soft commodities such as coffee, cocoa, and sugar.

So, we see a variety of opportunities for investors in the commodity space. Among other recommendations, investors can consider using second generation commodity indexes, such as CMCI, which aim to reduce the cost of rolling futures contracts for broad long commodity positions. More specifically, we remain positive on a range of precious metals, including gold, silver, and platinum. We anticipate even bigger gains in industrial metals and energy. Specifically, we expect the recovery in oil to continue. For more conservative investors who are able to use options, as an alternative to being long, the pickup in option volatility across all precious metals offers an opportunity to sell puts and earn yield from the option premium. Similarly, in oil we recommend considering selling puts in Brent crude with strike prices below current levels and with a maturity of six months. For more details on how to gain from a commodity rally, see our recent report "Commodity markets: Next leg higher (PDF, 6 MB)."

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