Commodities- against the inflationary headwind.

After a decade in the doldrums culminating in negative oil prices in April 2020, commodity prices exploded into life. Catalysts for the move include a strong rebound in global growth, the acceleration of the energy transition, the Russian invasion of Ukraine, and a growing list of supply side problems. More recently, the loosening of Chinese policy to stop the rot in the property sector and the relaxation of its zero-Covid policy are helpful. In recent months, commodities have sold off aggressively as the market has shifted from concerns over inflation to concerns about growth. Although we agree that there is significant potential for a disappointment in growth in the coming year due to fiscal retrenchment and tighter monetary policy, we believe that the structural underpinnings of a bull market in commodities remain in place.

Many of the recent supply issues were directly related to the pandemic and have largely abated, only to be replaced by problems relating to the Russian invasion. 

However, there are other, more structural factors that are more enduring and more important. Firstly, a decade-long commodity bear market has seen a collapse of investment in bringing new supply onstream. New discoveries of key resources like oil and copper have been anaemic by historical standards in recent years. Addressing this will take years or even decades at best and may be impossible where structural shortages exist. Secondly, increased geopolitical tensions drive competition for critically important resources.

Commodities prices remain historically depressed relative to financial assets. Investor sponsorship remains tiny relative to the traditional asset classes and, within equity indices, energy and materials represent only a small fraction of the market. For example, the combined size of the two sectors represents only 7.6% of the S&P 500. There are certain environments (inflationary or periods of financial repression) where resource stocks can dramatically outperform headline indices. Diversification benefits alone demand a non-trivial allocation.