By Nitesh Shah, Director of Research, WisdomTree Europe & Aneeka Gupta, Associate Director, Research
Any investor who has allocated to commodities over the last decade has experienced a difficult ride.
- We've had blockbuster returns in the S&P 500 Index over the last 10 years, at more than 13% per year.
- High-quality U.S. fixed income, as seen in the Bloomberg Barclays U.S. Aggregate Index, generated returns of approximately 3.5% per year, even with historically low interest rates.
In contrast, the Thomson Reuters Equal Weight Commodity Total Return Index, after keeping pace with U.S. equities from the start of the period through the halfway market in 2011, produced a steady decline into negative territory, losing 2.26% per year.
After such a difficult decade, with equities and fixed income doing well, and commodities steadily losing money, we'd imagine that many investors might be wondering why they should have commodities in their portfolios at all.
Figure 1: A Decade in Which Core Assets Have Performed but Commodities Have Not
2019 Could Mark the Start of a New Trend
Despite this pain, we're broadly constructive on commodities in 2019. Here's why.
Gold is Bouncing Back
We are already witnessing a gold recovery as investors rediscover the virtues of its defensive traits. A wobble in equity markets at the end of 2018 reminded investors that hedging portfolios is valuable. That drove positioning in gold futures markets from negative to positive. With geopolitical risks lingering in 2019, we expect gold to remain in favor. Silver, which has a close correlation to gold, is likely to gain a tailwind as well.
Oil's Supply & Demand Balance May Stabilize
After sanctions against Iran, implemented by the Trump administration, turned out to be not as harsh as markets expected, oil was in oversupply toward the end of 2018. However, OPEC has committed to cut supply, which will bring the oil market close to balance and likely reverse the price weakness we saw in the final months of 2018. Heating oil will likely see demand increase as we approach the implementation of International Maritime Organization's 2020 regulation (IMO 2020), which will restrict the amount of sulfur emissions from ships.
Do Not Forget About Copper
A potential easing in trade tensions between the U.S. and China could benefit copper, which came under pressure last year as the market feared lower demand for the metal. Any additional stimulus activity from China could also drive demand higher. China is the largest consumer of copper, and it has a history of stimulating its economy by endorsing infrastructure projects, which are often copper-intensive when economic growth slows. Copper is already in a supply deficit (mine supply is lower than demand), so inventories are being drawn down.
Agricultural Commodities Could Stage a Recovery
The most important consideration when analyzing the Thomson Reuters Equal Weight Commodity Total Return Index is that an equal-weighted approach tends to overweight agricultural commodities in comparison to other common benchmarks, such as the Bloomberg Commodity or S&P GSCI indexes.
Agricultural commodities have been deeply influenced by the ongoing trade wars between the U.S. and the rest of the world.
Soybeans are the most important U.S. agricultural product by far. Over the course of 2018, the ongoing trade spat between the U.S. and China resulted in a 49% plunge in Chinese soybean imports from the U.S., according to Custom's data. Since the announcement of the 90-day trade truce on December 1, 2018, China's initiative to purchase more agricultural raw materials from the U.S. has helped buoy sentiment toward agricultural commodities.
In December, China placed significant orders for U.S. soybeans. Specific data is lacking due to the U.S. government shutdown, but China has promised to continue increasing its purchases of U.S. agricultural products to reduce the record-high trade surplus. In response, soybean prices have been rising since the start of 2019. We are now seeing evidence of China opening its market to U.S. agricultural products. For the first time in 18 months, the Chinese Ministry of Agriculture approved five genetically modified varieties for imports, which could benefit both U.S. corn and soybeans. In an effort to avert the threat of auto tariffs, Europe has also promised increased purchases of U.S. soybeans. According to European Commission figures, the European Union (EU) also imported considerably more soybeans from the U.S. in the second half of 2018, more than twice as much as in the same period last year, which gives the U.S. a 75% share of the market for EU soybean imports.
Weather is a key factor affecting agricultural production and prices. According to the National Oceanic and Atmospheric Administration (NOAA), there is an 80-90% chance of an El Niño developing this (Northern Hemisphere) winter and close to a 65% chance of it lasting until (Northern Hemisphere) spring. The effects of El Niño include specific wind patterns across the Pacific Ocean, heavy rain in South America, and drought in Australia and parts of Asia, which can have a significant impact on the fortunes of the agricultural industry. Meteorologists currently favor a weak El Niño event, which could limit impacts on agriculture. However, forecasts continually evolve, so it is worth monitoring this source of risk. If the weather event becomes intense enough, we could see cocoa and sugar production decline, lending support to prices. In past El Niño events, these two agricultural commodities experienced more consistent price behavior than other commodities.
In short, commodities have had a brutal 10-year run, but several factors give support to 2019 becoming a turnaround year.
Unless otherwise stated, all data is sourced from Bloomberg as of 1/30/19.
Nitesh Shah, Director of Research, WisdomTree Europe
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.