2018 – Commodity Bull Market!

The evidence is mounting that the low point in commodities in early 2016, led by the plunge in oil prices, was a major secular low for the asset class and it has entered a new bull market. Broad based commodities, as represented by the Rogers International Commodity Index® (“RICI®), ended the year on a positive note for the second year in a row. Commodities appear poised for a multi-year reversion to the mean.
(View Chart Here)

The following are a few data points worth considering as potential positive indicators for the asset class.

Commodity Price Performance Accelerates

Commodities were positive five of the last six months of 2017. The RICI® was up 11.3% since the end of June, on par with the S&P 500 which was up 11.4% over the same time period. With all of the attention focused on the new highs in equities, many investors may not have realized that commodities were showing similar strong returns over the past several months. Of course, equity prices are well into all-time highs and nearly so in valuations while the commodities comprised in the Rogers International Commodity Index® remain on average over 40% below their previous 19-year highs.
(View Chart Here)

Analysts, Banks and Research Firms are Beginning to Increase Their Outlook.

After two positive years in a row, continued improving fundamentals, and their recent strong performance, commodities are beginning to gain more attention:

  • Jeff Gundlach, CEO and founder of DoubleLine Capital and who some call the “Bond King”, was interviewed at length on CNBC. When asked for his recommendations for 2018 he led with broad based commodities as his number one pick.
    (View Article Here)
  • Raymond James Chief Investment Strategist comments positively on commodities:
    “One thing we have observed over the past month or two is noticeable weakness in the U.S. Dollar Index with a concurrent pick-up in price for many commodities. We think that sequence may be setting the stage for a bullish change in trend for commodities. This would make sense because commodities are pretty much unloved and under-owned. That has left the Reuters/Jeffries CRB Index at its cheapest level relative to stocks in decades.”
    (Jeff Saut, Morning Tack, 1/2/18)
  • Goldman Sachs maintains 12-month overweight on commodities: “Given that equities are supported by robust views around future growth, should these views falter even as current activity remains robust, commodities should outperform equities and other asset classes, reinforcing our overweight view,” analysts including Jeffrey Currie wrote in the report. Strong global demand growth across raw materials reinforces the case for owning them.
    (View Article Here)
  • State Street Global Advisors’ capital markets assumptions now have their long-term estimate for commodity returns on par with their long-term equity forecast (5.2% versus 5.8%).
    (View Commentary Here)

Inflation on the Horizon?

With the Producer Price Index (“PPI”) beginning to trend sharply higher in the US and European Union, how long will it be before the CPI follows suit?  The U.S. Bureau of Labor Statistics reported the PPI for final demand increased 0.4% in November (seasonally adjusted). On an unadjusted basis, the final demand index rose 3.1% for the 12 months ending November 2017, the largest advance since a 3.1% percent increase for the 12 months ended January 2012. (12-12-17 BLS). This recent uptick in producer prices can also be seen on the OECD database.
(View Chart Here)

Interest Rates and the Fed

  • In December, the Federal Reserve followed through with its third rate hike of the year with expectations of further increases in 2018. The Fed also confirmed that it would step up its pace of monthly shrinking of its balance sheet beginning in January 2018.
  • Rising rate environments and tightening fed policy both tend to be positive for commodities and their value as a portfolio diversifier. Treasury yields have begun to rise with the 2yr hitting multi-year highs. Although the jury is still out, the possibility of higher rates continues to grow.

Even long-term US Treasury yields recently have begun to climb.

Global GDP Strengthening

A number of indicators appear to be pointing toward stronger synchronized global growth which is positive for the demand for raw materials. The OECD is looking for 3.7% growth in 2018, after growing a stronger than expected 3.6% in 2017.  For example, the Global Purchasing Managers Index (“PMI”) is trending higher and an indicator of future GDP growth.

A global manufacturing boom should send the world GDP growth to a multi-year high. (WSJ, Capital Research)

Infrastructure Spending: Potential for Major Boost in Demand for Raw Materials:

  • CNBC reports that the current administration plans to move forward with a long-promised infrastructure plan in January 2018, White House officials say. Details could be released before the President’s State of the Union address.
    (View Article Here)
  • There need for infrastructure spending globally is massive and is well laid out in numerous lengthy research publications from the likes of McKinsey & Company, PwC, and many others. We wrote about infrastructure as an upcoming catalyst for commodity demand in the years ahead in our blog post on June 5, 2017. (Read: INFRASTRUCTURE! THE LONG-TERM DEMAND FOR COMMODITIES IS GROWING)

Has the Dollar Peaked?

Although a weak dollar is not always needed for commodities to rise, it certainly is another global macro factor that has become positive for commodity prices.

Conclusion

With prices still low and the fundamentals of demand and supply improving, we believe the commodity asset class has entered a new bull market and the multi-year reversion to the mean relative to financial assets is just beginning. There are a number of global macro forces that have the potential to develop which will add long term support to the eventual rise in commodities and the diversification benefits for portfolios.

Alan Konn

Partner & Managing Director of Price Asset Management