Commodities Still Proving Inflation Hedge Mettle

Rapid deterioration in bond and stocks this year, though obviously bad news, is making it easier to identify winning asset classes.

Few and far between as they may be, an obvious standout among asset classes this year is commodities. Check out the S&P GSCI Total Return Index, which is higher by almost 49% year-to-date. Thank inflation, among other factors.

With other assets failing as inflation hedges, commodities are in style and that’s a positive for advisors at a time when clients are increasingly concerned about the ravages of soaring consumer prices on their portfolios.

Between the aging business cycle, high inflation, elevated demand, crimped supply and geopolitical risk, the stars aligned for more commodities upside this year. Some market observers even go so far as to say that's it's time for clients to increase commodities exposure as an avenue for diversifying 60/40 portfolios.

Owing to elevated demand from the renewable energy industry, crimpled supplies at the hands of years of lack of investment and other factors, some market observers believe a new commodities supercycle could be afoot.

Commodities Case Is Strong

In a turbulent year for equities and fixed income assets, it’s obviously a boon for clients that commodities are living up to their inflation-fighting reputation, but there’s more to the story.

Perhaps equally as important is the point that commodities are acting as portfolio diversification tools at a time when such assets are sorely needed.

Commodities are one such asset. The correlation between equities and commodities has been declining, while commodity correlation with bonds remains in negative territory. (What is good for commodities—rising prices that fuel inflation—has been bad for bonds.),” notes WisdomTree Global Chief Investment Officer Jeremy Schwartz.

On this front, commodities are again living up to historical billing. In previous market environments when equities faltered and bonds provided no shelter from the storm, commodities held up well. Again, inflation helps. As Schwartz points out, among domestic stocks, corporate bonds and Treasuries, commodities are the only member of the group with a positive beta inflation.

That’s certainly good news because clients are engaging advisors regarding increasing commodities allocations and because there’s  no sign of inflation materially relenting over the near-term.

Just Roll With It

As advisors know, one of the primary issues with allocating to commodities, particularly those that aren’t precious metals, is that many broad-based funds in this category are futures-based products. Meaning futures are rolled are every month, leading to higher costs and, potentially, subpar returns for investors.

Fortunately for commodities-hungry clients, data indicate roll costs are declining in this new commodities bull market.

“If we go back to 1999, the average cost to roll futures (measured as the difference between the Bloomberg Commodity Spot Index and the Excess Return Index of the futures) was nearly 7% a year,” adds Schwartz. “But the latest differentials show the costs have been declining, and they even turned into a positive contribution to returns.”

Over the past year, energy commodities lead the way in terms of excess return minus spot index performance, but grains were also impressive on this front. That’s an indication advisors may want to lean toward broad commodities strategies that agriculture- and energy-heavy.

Related: Physical Gold And Gold Equities Have Helped Offset Market Losses