When the stock market has had a bull run like the recent one, and is hitting new highs virtually every day, a growing proportion of investors start to feel uneasy about a possible correction. The saying is that stocks climb a wall of worry – it seems that some investors are now waiting for the first cracks to appear. Reuters reported recently that there is a growing trend for investors to look at diversification strategies – for example switching some of their portfolio into commodities.
At the moment, it’s a very benign outlook for equities. Growth is reasonably robust worldwide, corporate earnings are healthy and interest rates continue to be very low by historic norms. The S&P 500 has responded to all this good news by putting on 16% this year, reaching an all-time high in early November.
But commodities haven’t been left out of the story. The S&P Goldman Sachs Commodity Index could only manage a 7% rise during the period. And if you go back and chart the last five years, the contrast is even starker. While the S&P rose 82%, the GSCI fell 34%.
Commodities tend to be cyclical however, and the cycle is showing signs of turning according to some investment analysts and portfolio managers. Demand for copper and oil is strong, and supplies are not as plentiful as they were. Copper scored a three year high recently, and oil prices were at their strongest for the last two and a half years.
Commodity markets are nothing like as big as the fixed income and equities markets. Still, a marked shift towards commodities may bolster the case of those who claim that stocks are now overvalued.
$324 million has moved into commodities over the past week. Most of this went into funds that invest in a diversified range of commodities, such as exchange traded funds and mutual funds investing in commodities. In August this investment flow was higher than for the last six years, reaching $2.1bn. However far less has gone into commodities this year than in the same period in 2016.
Roland Morris, Portfolio Manager and Commodity Strategist at VanEck Global, is quoted by Reuters as saying that there has been a terrible bear market for commodities, with a tremendous bull market for equities. He feels both trends are about to change.
Earlier, in 2016, commodity prices plunged to multi-year low levels, before steadying. However commodities haven’t been able to keep up with stocks because of gluts in the supply of grains and energy, both heavily traded.
The gap between the S&P 500 and the GSCI is close to being the widest on record. This spread has been boosted by the fact that whereas after the initial investment, it need not cost anything to hold equities, commodities can be an expensive holding if prices dated in the future are higher than current prices. Passive investors lose when commodity index managers sell cheaper near-dated contracts and then have to buy more expensive futures contracts to replace them.
Take spot US crude oil futures. The contract for these has risen almost 6% in a year. But the index that replicates the contract’s daily price movements, is down 2.8% in a year. However, the reverse is true for Brent crude. Later-dated prices have fallen below the spot price, so managers selling contracts in order to buy future ones make money instead of losing it.
Reuters quotes Greg Sharenow of PIMCO, as saying that oil has a positive roll yield for the first time in years. (Roll yield is the profit available when as described above, the roll over from near term to further away contracts, creates a profit). This is one of the indicators that has been sparking interest in commodities.
There’s a psychological barrier for Brent crude at $60 a barrel, and Brent has already gone through it. So if US crude can follow, many investors will start looking at commodities with renewed interest.
There’s also increasing interest in other commodities, such as livestock and industrial metals. These have rewarded investors with the highest returns this year. Goldman Sachs is forecasting returns of 3.6 from the index, over the twelve month period.
