If Economic Recovery Gains Momentum, Commodities Will Come Calling

When it comes to advisors allocating to commodities in client portfolios, there's not a one-size-fits-all approach, but there are some oft-used standards.

Conventional wisdom dictates that for many clients, commodities allocations of five percent to 10 percent are acceptable, but there are occasions when 25 percent is suitable. While 25 percent is probably on the high end for most clients, the current environment is ripe with commodities opportunities, meaning advisors may want to chat with clients in the five to 10 percent allocation range.

Obviously, this is a weak dollar climate, one forced by the Federal Reserve's easy monetary policy. That's a plus for commodities because gold, oil, silver and the like are denominated in the dollars and commodities typically move inversely of the greenback. On a related note, all that Fed easing and low interest rates, which will likely be in place for another two or three years, are scenarios that can ignite inflation. Periods of rising consumer prices are historically efficacious for commodities because commodities are premier hedges against inflation.

“While the end date of the crisis remains unknown, US and global economies will ultimately recover and demand for raw materials should return,” according to FlexShares research. “And should historical trends continue, commodities and natural resources could continue to offer the potential for income, inflation hedging, and capital appreciation.”

Good Time to Consider Commodities

Easy money and the potential for inflation to rear its ugly head aren't the only reasons for advisors to evaluate commodities today. Economic data confirm as much. Consider the following: Last April, owing to the coronavirus pandemic, the ISM Manufacturing Purchasing Managers Index (PMI) hit its lowest levels since the global financial crisis.

Since then, a legitimate rebound is taking place with the December 2020 reading of the Manufacturing PMI reaching its highest levels since early 2018.

“With consumers unable to spend on leisure items, such as dining out, vacations, etc., household spending has apparently shifted gears towards expenditures that are more stay-at-home-centric, like appliances, household renovations/improvements and automobile sales,” notes WisdomTree. “With many of the nation’s factories shut down during the first wave of the pandemic, a trickle-down effect occurred whereby production of industrial commodities fell, inventories declined and vendors/suppliers became overly cautious of the outlook.”

Over the past six months, the WisdomTree Continuous Commodity Index Fund (GCC), a broad basket of agriculture and energy commodities and industrial and precious metals, is higher by 14 percent. That performance is being buoyed in part by industrial commodities, which are rebounding as manufacturing picks up.

“Perhaps even more notable, what this renewed factory activity has meant for commodities prices is that the prices for aluminum, copper, steel scrap and lumber have all gone up,” according to WisdomTree. “In fact, in the January 2021 ISM report, the price component rose to its highest level since April 2011, with all 18 industries in the survey reporting paying higher raw material prices.”

Shiny Idea for Renewable Boom

Chances are advisors are hearing quite a bit about silver lately because it was a brief, failed target of a WallStreetBets-orchestrated short squeeze.

Moving beyond that noise, silver is essential for the advancement of green energy and that's true even with silver thriftings for solar panels declining. I mention silver's place in the renewable energy boom because, as many advisors know, this is a centerpiece of President Biden's agenda and silver's clean energy applications extend far beyond solar.

“The demand for silver in three key ‘green’ applications to be in the range of 110-140 million ounces each year from 2018 to 2030, with growth in both automotive and solar applications bolstering demand in the longer term, while nuclear provides a much smaller, but nonetheless positive, benefit,” said the Silver Institute.

Bottom line: Solar is still important to industrial silver demand, but if electric vehicle makers successfully integrate the metal into the battery production process, price appreciation could follow.

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