Commodities may be an investor’s best friend in 2019, especially with geopolitical events and potentially slowing global growth being sources of concern impacting the equities and bond markets. In fact, “commodities will likely outperform equities in 2019, and those with the ability to invest tactically will further outperform,” said Tim Pickering, founder and chief investment officer of Auspice Capital Advisors.
Other managers agree that commodities may be a bright spot on the 2019 horizon, but “uncertainty” still seems to be the key word, at least according to Terence Brennan, portfolio manager and analyst with Lazard Asset Management.
“The biggest problem for commodities in general is uncertainty,” he told ThinkAdvisor. “The trade war [between the United States and China],” means a “slower growth environment.”
Brennan explained that the United States and developed markets have been set up for free trade for decades, “so this sudden shift … and the length of the free trade environment that is trying to be reversed, means there are going to be large discrepancies and imbalances.”
There already is an imbalance in aluminum, he pointed out, where the United States consumes eight times more aluminum than it produces. “That’s not healthy as [a trade war] really exposes us, even though it’s meant to protect the aluminum smelting industry and manufacturing in the U.S.” He said they are starting to see that with steel as well. He added that until these producers can ramp up capacity, “which is years away, [an imbalance] can cause disruption and uncertainty in their specific markets.”
This type of environment is “regressing back to the 1970s,” he said, adding that it “creates inefficiency and destroys value.”
With the trade war and slowing global GDP comes the danger of deflation — especially considering the debt to GDP ratios that have “sloped massively upward since 2007, [starting] right before quantitative easing” — although he says the real risk is “duration,” or the sensitivity of a price of a bond to a change in interest rates.
For these and other reasons, he’s upbeat on commodities because “the diversification benefit is back” as they are “zero duration” assets. “Commodities today are back to where they were from a correlation perspective, to pre-QE, so as the market goes from quantitative easing to quantitative tightening, or more normal price discovery, commodities give you diversification benefit.”
He recommends investors stay as close to the asset as possible, therefore buying commodity futures and an equity in the top quartile of related companies in exploration/production.
“That’s our approach,” he said. “It gives us pure empirical exposure to commodities because commodity-related equities have very high correlation to the commodity, so we don’t compromise our diversification benefit. It broadens your opportunity set to find a return and more often than not it does it with less volatility.”
Pickering doesn’t agree with that particular strategy, stating “commodities are great diversifiers but the common mistake is getting exposure through resource equity and other equity proxies. A tactical long/flat or long/short [of the commodity] approach is the way to go,” he said.
Schroders, too, is positive on commodities in its 2019 outlook. Although trade wars and slowing global growth have “gnawed away at investor confidence … we think the outlook for commodity returns in 2019 is positive,” wrote Mark Lacey, head of commodities, and James Luke, fund manager, metals, at Schroders. “Looking ahead, there is an obvious contrast between tight supply and demand balances and macroeconomic worries.”
They note that inventories in both crude and aluminum are being drawn down, which should continue to happen and in fact, accelerate. Further, rising interest rates could mean a weaker dollar, which would help commodities, they state.
Overall, they are bullish for crude oil over the next 12 months “as we expect the market to re-tighten,” noting that demand continues to be strong and spare capacity is at historic lows.
Pickering, too, is bullish on crude, stating “the commodity is undervalued and will go higher in 2019. It is the path that is the trick. Crowd behavior is pulling oil down at this time — so we are watching for positive momentum.”
On the metals side, for Schroders, aluminum stands out as “prices are extremely low relative to costs and a large deficit will likely drive prices higher.” They also note that “precious metals are currently very out of fashion,” but a slowdown of economic growth could spur these markets.
Pickering is cautious on precious metals but says they “may pick up given stock market weakness.” He added that a “greater risk of a recession in 2020 will weigh on some commodities, but we think that is priced in.”