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Adding commodities to the mix

Adding commodities to the mix

05-06-2020 | Monthly outlook
The time has come to take a second look at commodities as we emerge from the Covid-19 recession, says multi-asset specialist Jeroen Blokland.
  • Jeroen Blokland
    Jeroen
    Blokland
    Portfolio Manager

Speed read

  • We believe commodities offer upside as the world emerges from slowdown
  • Anti-viral measures impact services sector more than manufacturing
  • Precious metals and gold in particular also act as a hedge if things go wrong

He says the usually much unloved asset class has enormous potential once the worst of the economic slowdown induced by the lockdowns has passed. Robeco’s multi-asset strategies have increased their weighting to commodities – and to industrial metals in particular – in an effort to benefit from the recovery.

“We believe we are at, or just past, the low of the Covid-19-induced recession,” says Blokland, senior portfolio manager for Robeco’s multi-asset range. If our conclusion is correct, “This means global demand will start to improve from here. This will also be the case for commodities, and for industrial metals in particular.”

“At the same time, supply-side adjustments within the commodity space are starting to take shape as well. Precious metals also offer upside potential in different economic circumstances, particularly if there is a setback in the global economic recovery, or if inflation expectations start to move higher. Hence, we believe that the time has come to overweight commodities from a tactical perspective.”

Manufacturing versus services

Blokland says the current evidence suggests that manufacturing will emerge more strongly from the coronavirus recession than the services industries, which are still subject to virus containment measures such as social distancing.

“The prevailing measures will have a longer-lasting impact on certain services-related industries than on manufacturing industries,” he says. “The latter represents the bulk of commodity demand. The fact that services purchasing managers’ indices (PMIs) around the globe fell to much lower levels and have since recovered by less than manufacturing PMIs supports this assumption.”

“In addition to the return of demand, we also expect the supply side to adjust. A rebalancing in commodity markets has started and will continue in the coming months and quarters. Oil is a good example of this, with OPEC+ cutting supply by almost 10 million barrels a day.”

“For industrial metals, we expect this rebalancing to occur as well, albeit in a less centralized way. Metal markets are characterized by huge geographical distances between producers and consumers. This means industrial metal inventories spiked in recent months as production had literally nowhere to go, due to the lockdown measures imposed.”

Commodity prices are seen rising again. Source: Bloomberg, 31 May 2020.

A good diversifier

Apart from representing what we feel is a good investment on the basis of expected economic recovery, Blokland says that precious metals can be a good diversifier in a portfolio. This can act as a hedge (a form of insurance) should things not go according to plan.

“Gold in particular has qualities that in our view make it an attractive hedge in different macroeconomic scenarios,” he says. “Its safe haven status was convincingly confirmed when the coronavirus hit the global economy. The price of gold rose to above USD 1,700 in April, nearing the highs of 2011 and 2012. Gold realized a positive return of more than 6% during March and April.”

“A renewed downturn is not our base case, but given the ongoing extraordinary stimulus by central banks and governments around the world, we believe there is room for inflation expectations to rise once the disinflationary shock is behind us and the recovery gets underway.”

The ‘ultimate real asset’

“Seen by many investors as the ultimate real asset, we have seen that gold has performed well historically when inflation expectations have risen. Currently, inflation expectations are very subdued. While it may take some time for an inflation overshoot to materialize, we do not rule this out further down the road. Not in the least, because we think a large part of the stimulus will not be reversed any time soon.”

“A steady rise in inflation (expectations) would also likely push outwards the discussion about debt sustainability. Central banks have already indicated a willingness to let inflation in their jurisdictions run above their target levels. We believe that gold will do well if growth and inflation return.”

And don’t forget gold’s younger brother, silver, he says. “Under these circumstances we also believe silver has positive performance potential. First, because we have observed that silver and gold move in tandem most of the time. And second, because unlike gold, silver is used industrially (in alloys, electronics) and would therefore benefit from a return of global demand. In recent years, the gold/silver ratio has reached extreme levels. We expect some mean reversion of this ratio to occur once industrial demand comes back.”

Reducing the emerging risk

Increasing exposure to commodities has meant having to reduce the weighting of emerging market equities, an asset class that historically has been closely related to commodities, which are mined by many developing nations.

“Emerging market equities are pricing in a significant, if not V-shaped, recovery which leaves little room for error,” Blokland says. “This is certainly not our view for commodities. We expect the relative performance of commodities to turn as the economic recovery gets underway and supply and demand rebalancing takes hold.”

“Out of all the risky asset classes, we believe commodities have priced in the least amount of the global economic recovery that we see happening in the upcoming quarters. The combination of demand and supply rebalancing and a clear improvement in GDP growth numbers following this historical economic decline should, in our view, push prices of industrial metals higher.”

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