Commodities - Where next?

For this week’s In Focus, Sarah Gresty (Head of Investments) interviews Will Hobbs (Chief Investment Officer) and Jean-Paul Jaegers (Head of Asset Allocation) on the outlook for commodities after a stellar year in 2022 for the asset class. With a global recession ahead, do we still want exposure?

Sarah Gresty – We had an excellent article from one of the team, Patrick Bielstein, on the role commodities play in multi-asset class funds and portfolios last year (Commodities as a diversifier, In Focus, 14 January 2022). In his article, Patrick demonstrated very neatly the appeal of diversified commodities as a long-term investment in concert with stocks, bonds and so on (Figure 1). Here, I want to dig into a few more specifics on the subject with Will Hobbs and Jean-Paul Jaegers.

Will, starting with you, commodities were the best performing asset class last year by a distance. However, I’ve heard you, JP and others talking about the likelihood of a global recession this year, surely this would argue for holding less?

WH – Yes there is a logic to what you say Sarah, the demand for commodities can wax and wane with the wider global economy. To the extent there is a slowdown or recession this year, you would be wise to expect that to hit demand for certain commodities such as oil as activity swoons. However, there is more to consider, as you might have guessed.

First, China really is the whale in the bathtub when it comes to most commodities, whether energy or industrial metals, China represents a huge share of global demand (Figure 2). To that extent, the reopening of the Chinese economy is a big deal. This is not just the fact that Chinese domestic and international travel will recover – remember the Chinese tourist was far and away the largest aggregate spender pre-pandemic[1] – it is also the real estate market. For the latter point, it is interesting that we are seeing policymakers relax some of the recently imposed strictures.[2]

Second, with regards to commodities (as with everything), we need to think about both demand and supply. Assessing supply in many of the commodity sub-sectors is certainly challenging. OPEC (Organisation for Petroleum Exporting Countries) controls most of the oil supply and does so with often opaque objectives at work. However, more broadly we can see that investment in fresh supply has fallen over multiple years (Figure 3). We can also say that inventories are low pretty much across the board.

JP – I would add that Will is talking about some of the factors determining price swings on a minute-to-minute basis. As investors, we need to be humble and realise that our ability to second guess a lot of these swings is minimal. The point about diversified exposure to commodities is the collection of something a bit different and potentially a bit more reliable – a risk premium. This can get a bit academic, and I don’t want to put you all off! However, one particularly interesting thing about commodities to us is that the return that you can get, beyond these wild swings in spot prices, often seem to pop up at times when much of the rest of your multi-asset class fund is struggling. Much like last year – stocks and bonds had a famously bad year, however commodities came to rescue.

SG – Why is that? I’m sure there must be lots of theories?

JP – Well, you asked for it! Yes, the more credible theory to me surrounds something called the Theory of storage. This is actually a very old idea that has been honed over the decades. Like the risk premia you can find evidence for in other asset classes, this is about the idea that for most risk, there is a roughly proportionate investment reward. It can get murky as I’m sure you can imagine - risk is difficult to measure and is perceived quite differently depending on where you are, what you do, how old you are, and more besides. However, here it is about compensating those holding commodity inventory for the risk that they run out of stock.

The so-called ‘convenience yield’ that links to this compensation tends to be larger over time than the returns from changes in spot prices. Perhaps most importantly, is how and when these returns tend to crop up as noted above. The result over time is smoother overall multi-asset class fund and portfolio returns.

SG – I know that this year we will be revisiting our long-term mix of preferred assets, our Strategic Asset Allocation. I get asked a lot about what will happen to the commodities allocation – has it served its purpose so to speak?

JP – We will have to wait and see. A lot has changed since the last refresh back at the beginning of 2021. The key is to look at the portfolio in aggregate. Yes, commodities have done well as traditional asset classes suffered. However, there will always be winners and losers in a diversified collection of investments. History amply demonstrates the dangers of selecting or deselecting individual assets based on whether they have recently served their purpose or not. Past performance needs to be handled with great care and it is the aggregate performance that really matters in the end.

[1] https://foreignpolicy.com/podcasts/ones-and-tooze/covid-anniversary-china-economic-crisis-public-health/

[2] https://www.bloomberg.com/news/articles/2023-01-06/china-may-ease-three-red-lines-property-rules-in-drastic-shift

Find out about our '?Ready-made investments ' via our Smart Investor platform. A selection of five Barclays funds that each aims to increase the value of your investments over time, using a broad mix of asset classes from across the globe.

Or

Learn about?Barclays Wealth Management , the affluent and high net worth service provider for Barclays UK.

*This article is for information purposes only. It is not intended as a product offer or investment advice