In many of our previous Investment Commentaries, we have emphasized that commodities have a historical tendency to mean revert regularly, due to the effects on prices of normal shifts in supply and demand. Following a protracted period of underperformance, prices eventually begin to recover, and such recoveries have almost always been multi-year in duration, with only one exception in our 47 year data set*. We have not really delved into the shape and trajectory of commodity price movement, however, and perhaps we should have.
After hitting a cyclical low in February 2016, only 1 of the subsequent 10 months exhibited a decline greater than 1%, which in the world of commodities is about as close to unbroken appreciation as it gets. The result was an excellent performance for the year, with out favorite RICI© index up +13.35% which beat even the S&P 500. Our call at the time was, of course, for this to continue. In 2017, after a couple of small positive months, commodity prices began to fade. By the end of the first half of the year, after 4 straight months of declines, the RICI© was down by -5.77%, dominated by a fall in crude oil prices. Naturally this led to a few pundits pronouncing that the commodities rally had come to the end of its brief run. This view proved to be premature, and commodities not only reclaimed the previous losses, but finished the calendar year 2017 up +4.88%.
Commodity price trends rarely conflict with the historical patterns. The most meaningful pattern is the following: once a recovery is established, its average length of persistence is approximately 4 years (although many have been longer). These are not “super cycles” by the way, they’re just cycles, and since 1970 there have been at least 5 major ones and a number of minor ones. But, they don’t always display a comfort-inducing straight line trajectory, and it’s important to understand this. During the bullish period between 1982-90, there were a couple of period of lackluster performance, years when commodities were up only 1 or 2%. The result for the whole period, for investors who stayed the course, was +315%. From 2002-07, there were 4 straight years of outstanding performance (+34.09%, +20.83%, +19.55%), followed by a year of only +3.05%. Investors could be forgiven for assuming that the market was exhausted, after a sustained rally of that significance. The following year’s performance? +30.01%*.
We are clearly in a bull commodity market, but investors should be cognized that the long-term nature of commodity price movement is not always straight-line appreciation. This is even more critical since all major asset classes and implementation styles have lately been overshadowed by all the attention on the equity market’s historical performance and recent volatility. But, perhaps the clearest way to make the point is this: since the end of that minor retracement that ended in June 2017, commodities have outperformed the S&P 500 by over 900 basis points**. Most investors would probably find that surprising.
With a commodity recover that may still be in its early stages in terms of duration, we should again note that commodity prices are also still relatively low, averaging approximately 48% below previous highs***. There is, purely from a price perspective, significant recovery potential ahead. This compares favorably to record, or close to record, levels in global equity market indices. Finally, even though the positive price performance of commodities occurred without the benefit of economic tailwinds (GDP growth, CPI, central bank rate policies, corporate earnings, etc.), those tailwinds now appear to be developing. The combination of these factors makes a strong case for the continuation of the bull trend in commodities.
Chief Executive Officer