It was not easy to find a safe haven during the first half of 2022. Shares and bonds fell in tandem, undermining the balanced funds that have given investors a smoother ride through the ups and downs of the investment cycle. Hopes that cryptocurrencies and gold would be effective diversifiers evaporated when they turned out to be risky assets in disguise.
Only commodities offered a port in the storm, with a 55 per cent rise in the oil price driving Bloomberg’s basket of natural resource investments 20 per cent higher since the start of the year, the mirror image of the loss recorded by shares over the same period.
It certainly hasn’t been an easy ride. The overall commodities index was 40 per cent up year-to-date as recently as May. It has since then borne the brunt of investors’ pivot from worrying about inflation to fretting about growth. The most economically sensitive resources, such as copper, have reminded us that commodity investing is not for the faint-hearted.
But as we navigate a crucial second-quarter earnings season, watching anxiously to see if company profits become the second shoe to drop after valuations, there’s a strong strategic and tactical case to be made for commodities. Investing in natural resources is not as simple as buying shares and bonds, but in an environment of rising interest rates, and in the face of a looming recession, it is time to cast the net wider.
The recent correction in commodity prices helps make the tactical case. Copper may have been hardest hit, down by a third since the spring, but oil has also retreated, even if you’d be hard pressed to notice the difference when filling your car. The price of Brent crude is back where it was when Russia invaded Ukraine. For both copper and oil, Mr Market has opened the door to a more rewarding entry point than at the recent peaks.
The short-term case against commodities playing out in these corrections is the decision by central banks, most notably the Federal Reserve, to prioritise inflation-fighting over growth. Just as Paul Volcker did in the early 1980s, Fed chairman Jay Powell has decided that maximum sustainable employment must for now play second fiddle to the war on prices.
But there is a longer term case for commodities, made by resources bulls like Goldman Sachs’ Jeff Currie. It pre-dates and will outlast current recession fears. He argues that Fed-induced slowdowns can only ever tame the symptom – inflation. They are incapable of addressing the underlying driver of sustainably higher commodity prices, which is underinvestment in the production of sufficient energy and other resources. The imbalances causing the cost of living crisis are physical and supply-driven. They cannot be resolved by destroying demand.
The world is anyway very different from that of 40 years ago. When Volcker jacked interest rates up to choke off the inflation which had scarred the previous decade, he did so after years of rising capital investment. The fall in demand that he engineered combined with adequate supply to quickly bring the market back into balance. That is not the case today after years in which capital has for too long been directed away from real physical assets. We are reaping the harvest of that misallocation.
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