Dear Mr. Market:
You’ve heard us barking about this before but as the world navigates its way out of the Covid-19 pandemic, it won’t be just the stock market that recovers. In many respects the market has mainly bounced back due to a lot of “sugar in the blood” from massive fiscal stimulus and has still primarily been led by some mega cap names. What’s brewing below the surface and actually could turn into something far more sustainable, is a boom in commodities.
Have you ever heard the expression “Even a blind squirrel find a nut once in a while?”
For starters let’s explain that commodity bull markets aren’t quite like those in other asset classes. To state that they’re fairly rare is an understatement. Believe it or not, there have only been six recorded in the past 227 years but there is considerable reason to believe we’re about to see a seventh. What we’re excited about is that it might last a decent while so don’t think you’ve already missed the boat.
The past year has obviously seen unprecedented action in so many areas of life. Throughout the pandemic certain commodities flourished initially then got clobbered. You’ve undoubtedly read our rationale on owning gold which did great all throughout 2020 until it’s sold off the past six months. Perhaps Bitcoin and some of the hot crypto currencies have taken some of the luster off but as we’re seeing… old habits die hard, weak hands get shook out, and gold will still be one of the best insurance policies to your portfolio that there is.
How volatile have commodities been? A top of mind example, almost exactly a year ago, was worldwide production shutdowns which created a glut of oil in 2020. At one point excess supply forced oil to cost more to store than it was worth!?! Theoretically you could literally drain your swimming pool and replace it with oil as someone would be willing to pay you for that trade. It was such an unusual time that we wrote an article and discussed the top oil stocks we liked amongst a very battered bunch. In particular we liked Conoco Phillips (COP) which at the time of our writing was trading at $29.25/share (it’s now at $55.44 and just surpassed our target of $54.87). Click here to view that article for some background and proof that we’re not cherry picking or pretending we have a crystal ball!
It’s not just “Joe & Jane Six Pack” or the novice investor who has abandoned commodities as many seasoned financial advisors have also fallen prey to recency bias. Most people simply don’t wake up thinking “Gosh…I need to invest in something that has been trashed and is down seven out of the past 10 years.”
You don’t have to enlarge the above chart to see that commodity returns are not only volatile but their performance over the past 10 years have been absolutely dismal (-48.93%). That being said, we’re reminded of the famous Wayne Gretzky quote of “I skate to where the puck is going, not where it has been.” It’s a popular quote because it illustrates something that everyone wants to do, but may not always understand how. On an absolute basis commodities also clearly present a challenge on how to do it since most people (even the most savvy professionals) are not equipped to sell wheat, buy cattle, or gain ample exposure to soybeans, oil, cocoa, or natural gas…to name several. The chart below not only shows you that like other investment asset classes there is often no rhyme or reason , nor pattern to follow, but also a wide disparity between yesterday’s winner and tomorrow’s loser. The year 2020, for example, saw the top performer being silver (in grey) with a +42.47% return whereas oil (red) got smacked down -50.71%. (click on the graphic below to enlarge)
What are some fundamentals supporting many expert opinions that we could be in the early innings of a long ballgame and a “Commodities Super Cycle“? Both monetary and fiscal policy are giving us some clear indications that this accommodative stance bodes well and has plenty of additional tailwinds for this asset class to flourish. The Fed balance sheet increased 76% in 2020 and U.S. money supply shot up 26%. It’s no secret that we’re witnessing unprecedented spending and there is more fiscal stimulus on the way… whether we agree with it or not. We’re coming out of the first major recession on record to ever see personal income increase while production dropped!
China has clearly telegraphed their plans to reset the global economic landscape. They have a 5-year plan that outlines their key areas of economic change and an aggressive run at global leadership. This will call for increases in crude oil, strategic metals, and farm goods to name a few. Couple all of this with a weakening U.S. dollar and there will be even more natural tailwinds for commodities as a whole. Historically there has been an inverse relationship between the dollar and commodities but even if we get a small near-term bounce, the dollar is likely to be flat to lower in the years to come. The dollar has fallen from its March 2020 peak by -12.53%. Searching for “value” in commodities is not quite like doing so when hunting for cheap stocks but historically we’re on the right side of that equation as well. While it may seem premature to call a bonafide “Super Cycle” being imminent, it’s very much like trying to predict the next recession; they’re always easier to see once they’ve already landed on your doorstep.
It may not feel like it arrives overnight but it’s already here. What is it? It is Inflation…
There is almost a perfect storm for inflation and perhaps the single best tool that will not only potentially diversify your portfolio but also help protect it, is by adding exposure to commodities. In short, clear up some space by trimming your bond and equity allocations and watch the supply-demand game help bolster returns in an area that most portfolios don’t have any exposure to.
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