The long-term case for diversifying clients’ portfolios with commodities is solid. But the performance of the major commodities indexes in the past few years illustrates the potential drawback to investing for coverage of multiple markets.
The Dow Jones-UBS Commodity Index peaked in April 2011. Although there have been a few upward-price reversals since then, the overall trend through 2013 has been lower.
Ed Egilinsky, head of alternatives for Direxion Funds in Milwaukee, Wis., cites several reasons for the overall weakness in commodities, including Fed tapering and a strengthening dollar among them. Nicholas Brooks, head of research and investment strategy at ETF Securities in New Yorky, points to slowing growth in China and expectations for greater supplies as additional factors.
The market indexes by definition include a large number of components. The Dow Jones-UBS Commodity Index, for instance, is comprised of over 20 weighted commodities. By drilling down into the individual commodities, however, it’s possible to spot those that offer potential profits over the next year or so.
One investment strategy is to follow price trends; that’s the approach Direxion takes with the 12 commodities it monitors for its funds. The firm follows a rules-based price-trends method based on an index licensed from Auspice Capital, a futures trader.
If a commodity’s price trend is positive, Direxion takes a long position. If the trend is negative, the funds go “flat” in that commodity and hold cash. That strategy can result in relatively few long positions at any one time.
As of Nov. 30, the Direxion Indexed Commodity Strategy Fund held only four long positions: soybeans, sugar, gasoline and heating oil. Corn, wheat, cotton, crude oil, natural gas, copper, gold and silver were flat.
Another approach is to analyze and forecast the fundamentals. Because that approach is forward looking, it can lead to different conclusions from following trends.
In early December, ETF Securities shared its commodity outlook for 2014, which focuses on supply and demand trends, particularly in China and the United States.
According to Brooks, “Prices have largely adjusted to expected increases in the supply of a number of key commodities. We think markets are underestimating developed economy central banks’ bias towards supporting growth.
“Healthy demand growth in the US and China, disappointments to current highly optimistic supply forecasts for a number of key commodities, and continued ample global liquidity should support commodity prices in 2014 in our view,” he noted.
The outlook highlights several key trends:
- Lead, copper, platinum and palladium could be the main beneficiaries of broadening global economic recovery.
- Gold and silver prices may be hampered by rising growth expectations, but supported by physical buying.
- Energy prices are likely to remain “range bound,” providing tactical range-trading opportunities.
- Agriculture price performance is expected to be diverse, with corn and coffee offering potential long opportunities in 2014.
ETF Securities says that these trends are part of its top investment picks for 2014, which include long positions in coffee, copper, corn, palladium, and platinum. Sugar is the sole short. The full outlook is available online.