Are Commodities Done?
Of course as soon as I write that title, I chuckle. So many times in my career, I have heard the extreme statements that a commodity will never move lower than price X or higher than price Y. A recent example comes up often that the advent of commercial electric cars will eliminate the demand for fuel and thus oil. Even Elon Musk has to laugh at that because what do you think powers his SpaceX rockets, pixie dust?
A common criticism is that commodities do not have the same yield or inherent return as equities and thus do not make sense to use in an asset allocation mix. This may be true, but that does not make including commodities in an asset allocation mix less important. In fact, the opposite is true given commodities are non-correlated to equities and bonds. For example, the correlation of the Bloomberg Commodity index to S&P500:
Yet, we believe the best way to use commodities in your portfolio is to use a tactical strategy. Being long select commodities as they rise, in cash as need be, and perhaps short as they fall. By doing this, one can lower that correlation even further.
For example, if you compare the Long/Flat Auspice Broad commodity index which takes tactical long positions in rising markets and to cash in falling markets, the correlation to S&P drops versus a long-only index:
The portfolio benefits are obvious: Including ABCERI in a diversified portfolio may improve overall performance while reducing volatility and drawdowns. This example shows an 18% improvement in annualized returns, 39% lower drawdown and 26% lower volatility (relative)
So when is the time to add commodities? Timing is always challenging and commodities have been sliding for the better part of 5-6 years. But as the chart below shows, commodity versus equity values have long cycles.
Given there is no specific floor, this value could fall further. However, given it has become so stretched we believe that the equity values are more at risk near term than commodity values. In fact, as the following charts show, the recent commodity performance is at the bottom end of the statistical distribution while equity is at the top.
(*Source Bloomberg and Summerhaven Investment Management)
The world is still growing and the developing Asian markets are not going away. The demand for fuel, food, materials is not disappearing. In fact, demand may become greater than supply as the developed world shifts investment into technology inspired sources and investment dollars become harder to come by for traditional commodities. Moreover, commodities cannot go bankrupt. Remember, a stock can literally disappear, while it is not likely for most major commodities anytime soon.
On a stand alone basis, the recent returns from the commodity sector are underwhelming, but when combined with a typical investment portfolio the benefits are clear. Now is a good time to look at commodities in an asset allocation mix. Consider ways to directly participate in commodities versus resource equity to reduce the stock market risk and beta. Look for tactical managers that specialize in commodity tilted investments.
IMPORTANT DISCLAIMERS AND NOTES
Futures trading is speculative and is not suitable for all customers. Past results is not necessarily indicative of future results. This document is for information purposes only and should not be construed as an offer, recommendation or solicitation to conclude a transaction and should not be treated as giving investment advice. Auspice Capital Advisors Ltd. makes no representation or warranty relating to any information herein, which is derived from independent sources. No securities regulatory authority has expressed an opinion about the securities offered herein and it is an offence to claim otherwise.
Auspice Broad Commodity Futures Excess Return Index (ABCERI): The Auspice Broad Commodity Index aims to capture upward trends in the commodity markets while minimizing risk during downtrends. The index is tactical long strategy that focuses on Momentum and Term Structure to track either long or flat positions in a diversified portfolio of commodity futures which cover the energy, metal, and agricultural sectors. The index incorporates dynamic risk management and contract rolling methods. The index is available in total return (collateralized) and excess return (non-collateralized) versions.
Returns for Auspice Broad Commodity Excess Return Index (ABCERI) represent returns calculated and published by the NYSE. The index does not have commissions, management/incentive fees, or operating expenses.
The Bloomberg Commodity (Excess Return) Index (BCOM), is a broadly diversified index that allows investors to track 19 commodity futures through a single, simple measure. Excess Return (ER) Indexes do not include collateral return.
The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. Price Return data is used (not including dividends).
60-40 Portfolio: 60% investment in S&P 500, 40% investment in Bloomberg Barclays US Aggregate Bond Index, rebalanced annually, monthly data.
For U.S. investors, any reference to the Auspice Diversified Strategy or Program, “ADP”, is only available to Qualified Eligible Persons “QEP’s” as defined by CFTC Regulation 4.7.
For Canadian investors, any reference to the Auspice Diversified Strategy or Program, “ADP”, is only available to “Accredited Investors” as defined by CSA NI 45-106.