BackWhither commodities?
The law of statistics tells us that the probability of supply disruptions rises with each normal year of production and supply
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I have written on many things recently, including the drop in gold prices, the money printing plans of the Bank of Japan and the disappointing US employment data, etc. The performance of stocks led by liquidity rather than by corporate and macro fundamentals has failed to impress me. Repeated bouts of money printing and free lending to banks at different points in time in the past four years have spurred the performance of stocks.
In contrast, I had taken the view that a more prudent and less risky way to add market beta to one’s portfolio was through commodities. Commodities are real assets and, to the extent quantitative easing programmes succeeded eventually in generating inflation, they would benefit as investors seek the safety of real assets. That logic has not played out well, especially since mid-2012. This column explores why and re-examines the relevance of commodities to an investor’s portfolio.
In general, the four major commodities groups—agriculture, energy, industrial metals and gold—had performed exceptionally well prior to the crisis in 2008. Industrial metals delivered a total return of 322% in dollar terms. Energy commodities and gold followed. Commodities began to falter in 2011. It continued in 2012 and became more pronounced in the second half of the year. Industrial metals that topped all commodities up to 2008 became relative laggards in 2010. Matters turned worse in 2011 and they became laggards in absolute terms too, delivering negative returns. Industrial metals reflect excess supply caused by heavy investments in mining, based on anticipation of continued Chinese demand. The stories of industrial metals and the China economic boom are over for now and may not return for a while.
Now, let us compare the performance of commodities versus global and US stocks. In general, as we saw earlier, commodities had not done badly in absolute terms after the crisis. Their relative underperformance began in 2011 and accelerated in 2012. In 2009, commodities did better than US stocks, measured by the Morgan Stanley Capital International (MSCI) Index of US stocks. Returns were comparable to the returns earned by stocks in the MSCI World Index. Inferior returns in 2010 were only relative. In 2011, commodities held their ground better than the MSCI World stock index. In 2012 and 2013 till now, commodities have fared rather poorly both in absolute and relative terms. It has been stocks all the way.
In 2002-08, commodities benefited from two tailwinds: the realization of the importance of real assets and the global growth boom. In particular, the Chinese economy was firing on all cylinders and that led to a real jump in demand for commodities.
In contrast to 2002-08, commodities have not had the benefit of global demand after the crisis. China is struggling and the problems run deeper than what many of us and the Chinese government care to admit. At the same time, the safe-haven demand too has waned as investors have judged that the world has recovered from the crisis. The euro zone has not imploded and the US dollar has not crashed. The US appears to be growing again (recent data shows how fragile this recovery is) and, hence, it is safe to go back to investing in financial assets, chasing yield. The insurance value of gold and other commodities is not required.
The third and the most important reason is the fact that supply risks that we had anticipated did not materialize. The Arab Spring or the Iran nuclear threat did not become serious enough to disrupt global oil supplies. The US reduced its oil imports substantially because it had discovered oil and gas reserves that could be extracted through fracking. We will have more to say on the recent medium-term oil market report of the International Energy Agency on another occasion. Despite volatile and extreme weather in many parts of the world, agricultural supply, barring select commodities, did not fall off precipitously.
Hence, the big question is whether one should abandon the investment case for commodities now on safe-haven and supply risks. I do not believe that printing of money will usher in a global economic recovery and, hence, I do not believe in investing in (or, being invested in) stocks at current prices. Corporate cash flows in the US are shrinking. Corporations have taken on more debt to engage in share buybacks to boost executive compensation. Europe is mired in a prolonged economic stagnation. In the second half of the year, more money printing is on the way from Europe and the US Federal Reserve will stick to its current pace of asset purchases. The safe-haven demand for commodities would then resurface. Finally, the law of statistics tells us that the probability of supply disruptions rises with each normal year of production and supply. Hence, now is the wrong time to give up on commodities.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk
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