It’s Time to Invest in Commodities. How to Do It.

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Commodities are rarely exciting—and the price of copper, corn, or even oil doesn’t excite investors the way a tweet from Elon Musk does. Yet the commodity sits at the crossroads of three of today’s biggest investment themes—rising inflation, a changing China, and the transition away from fossil fuels amid increasing attention to climate change.

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baron’s Highlighted the occasion a year ago as the commodity emerged from a decade-long bear market. It was a good call: The Businesshala Commodity Index rose 27% in 2021, its best year in decades. Those big three trends are still consolidating, so there could be more gains for some commodities, such as oil, and agricultural commodities, such as corn. But the rally in prices means investors need to choose their spots carefully. The factors affecting commodity prices — and determining what investors should focus on — often overlap and have different short- and long-term implications. Actively managed funds are better able to detect and take advantage of changing trends; For three good fund options, see this article.

inflation

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Illustration by Doug Chayka

Inflation has been one of the biggest drivers of many recent economic and market trends. The most recent Consumer Price Index, or CPI, inflation report showed that prices rose across the board in November — a considerable, 6.8%. And in December, the Federal Reserve acknowledged that inflation was indeed a permanent trend — not transitory — and that it is moving forward with a plan to raise interest rates to fight inflationary pressures. Even as the Omicron version spreads, the world is retreating from the pandemic lockdown. There has been an increase in the demand for essential items in household items, corporate endeavors, municipal projects and of course, all forms of production. Meanwhile, many of those items are in short supply. Add to that the supply-chain problems of getting those goods into production and the goods being produced to the end user, and it’s no surprise that prices are rising.

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Investors seeking to hedge against inflation, which makes stocks more volatile, have long turned to commodities. This is a broad “if- you can’t-beat-’em, join-’em” strategy: If inflation is rising, commodity prices are generally rising, so the portion of your portfolio will also gain some profit. Will happen. Investment returns are muted. Energy futures are best correlated with US inflation, but over the long term, agriculture, livestock and industrial metals are all positively correlated. According to JPMorgan, since 2000, the monthly year-over-year returns of the Businesshala commodity index have had a 76 percent correlation with U.S. consumer-price-index data. And today’s inflation is driven by structural factors that are transforming the economy, business and the lives of all of us.

“Greenflation” is an additional factor driving inflation, and will benefit commodities needed for the green energy transition – particularly copper, which is used in all things digital; Lithium, used for batteries; aluminum, used for the manufacture of solar panels and wind turbines; and cobalt, a catalyst for the production of a clean fuel. More companies and governments are setting goals to reduce or eliminate the use of fossil fuels such as coal, oil and natural gas.

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These efforts are the basis for plans to become carbon neutral or “net zero” that many companies and nations have made. These entities are setting dates by which their operations will not release carbon dioxide into the atmosphere, and any emissions they produce will be offset by green projects that reduce carbon. These are expensive, decades-old schemes that will change the supply and demand profiles of many commodities.

While inflation is a broad rationale for investing in commodities, the influence of China – the largest consumer of commodities – dynamics around specific trends, and already large increases in the prices of some commodities, mean that investors benefit from more targeted Will reach

China

The health of the Chinese economy is one of the biggest determinants of commodity pricing — and the near-term outlook isn’t great. The world’s second-largest economy was the primary driver for the final goods supercycle, as the country’s rapid urbanization, aggressive stimulus following the financial crisis, and rapid economic growth created tremendous demand. Today’s background is very different: China’s economic growth has slowed to 5%, and its policymakers are focusing more on building a balanced, resilient economy than on unbridled growth. An example of this change in priorities is Beijing’s crackdown on China’s debt-ridden property sector, by imposing fiscal regulations that pushed large property developers such as China Evergrande Group (ticker: 3333.hongkong) to the brink of bankruptcy, and That left investors worried that the asset woes would drag the economy down even further.

“Instead of industrializing one country, we have a country that contributes to a 55% reduction in demand for metals,” says Natasha Keneva, JPMorgan’s head of global commodity research.

Yet in the long term, China will continue to be a major driver of demand. Its property market accounts for 30% of global demand for copper, which means that copper prices are unlikely to benefit further in the near future.

But as China embraces green technology, the future of metals, and copper in particular, is bright. Beijing has announced plans to go carbon neutral by 2060, a transition that will take years to make and bodes well for industrial metals used in electric vehicles. Only a fifth of the cars sold in China today are some kind of electric-think battery, plug-in or hybrid, compared to 40% in Europe. Caneva says the demand for EVs probably won’t compete with the demand for conventional cars until after 2026. Unless China’s energy transition progresses and its asset sector stabilizes, industrial metals are not the best near-term option for combating inflation or boosting returns.

energy, green and black

Energy transition is another big factor in commodity prices, and one that is creating a lot of opportunities. As anyone who has raised a teenager knows, the transition can be difficult and full of struggle.

Three big forces are at play in energy prices: fuel shortages in the short term, a harsh march toward renewable energy in the long term, and a growing emphasis on environmental, social and governance issues from American companies and their investors, known as esg

All three forces are interconnected. To achieve their goal of being carbon neutral by 2060, Chinese policymakers imposed restrictions on factories last fall – resulting in power shortages that disrupted already tight supply chains and fueled inflation. Meanwhile, Europe is facing a fuel shortage that could lead to a blackout this winter, partly due to its growing reliance on wind power and the very few windy days in the past year.

In the US, alternative energy is in short supply, creating a backdrop for higher prices, thanks to two forces: demand for alternative energy has increased, while large commodity companies have invested less in their businesses over the years. This has created a shortage of old school commodities like oil and copper. Expect these shortages to continue as companies and countries around the world invest heavily in renewable energy, decarbonization and efforts to make buildings more energy efficient.

Investors have also increased their scrutiny of business practices, making it harder to mine items that are already in short supply. Rio Tinto CEO Jean-Sébastien Jacques and other senior executives have resigned after the company blew up a 46,000-year-old sacred Aboriginal site in Australia to mine iron ore. Similarly, the best copper deposits have already been discovered, with the remaining areas lacking ESG, says Suleiman Salim, senior research analyst at Calvert ESG.

Such challenges have prevented energy and mining companies from funding larger projects or ramping up production when demand increases. Instead, companies have used their excess cash to fund share buybacks or higher dividends, which compounded the lack of supply — all of which point to higher commodity prices over the long term. “The energy transition helps to reinforce the commodities story,” says Nicholas Johnson, who oversees $19 billion in commodity and multi-asset strategies at Pimco and manager of the Pimco Commodity Real Return Strategy Fund (PCRX). .

Agriculture

Higher energy prices cause the prices of some agricultural commodities to rise. Farmers use petroleum to power their tractors and other farm equipment, and fossil fuels are used to make fertilizer. The more expensive these energy inputs are, the more likely it is that farmers will plant fewer or raise prices on their produce, driving up the prices of commodities such as corn, soybeans and wheat.

Big trends are also working, setting a backdrop for strong gains in agricultural commodities. From…

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