Emergence Of A New Commodity Cycle: Opportunities For Investing For The Next 5 Years

The world is currently experiencing a new commodity cycle that resembles the one that occurred in the 1970s and the other in the 2000s. These periods of stunted commodities prices (1970 and 2000) gave way to overvalued equity markets and their other sequels — a situation that repeats itself presently.

These cycles generally last around 10 years, as that is typically the timeline for exploration, development, and production. There have been two in the past century and one such cycle currently, as shown in the table below. In each of these cycles, commodity prices have risen while stocks have offered minimal returns.

Source: Yahoo Finance and Goldman Sachs

To understand the current commodity market, you might need to reverse the clocks and look at different decades of financially challenging environments that led to backdrops of commodities outperforming the S&P500.

High Inflationary Era Of The 1970s

For instance, in the mid-1970s, the commodity boom was triggered by the US government putting the economy onto a path of deflationary recession. The gaping cuts in the money supply growth and high-interest rates overpowered the budget. It was an era of rapidly declining gold-exchange standards in the US. Vigilant investors realized how radically undervalued commodities had become relative to stocks in that decade, thus acquiring spectacular returns.

Financial Crises Of The 2000s

The first decade of the 2000s’ was marked by crazy tech valuations and housing concerns. The Fed drove interest rates through a rollercoaster, initially bringing them down and gradually elevating them until crises became evident. During these times, commodities (especially oil, around the early 2000s)  became comparably “cheap” relative to stocks. It eventually broke the bearish psychology and caused commodity prices to enter bigger bull markets. From 2000 to 2011, commodities returned 71% (according to GSCI Index), while the stock market returned -8%.

Current Macro Dynamics

The current market scenario has shades of both the 1970s high inflation and 2000s banking crises. After a decade of bull markets, commodities today are now priced reasonably relative to stocks as they could ever be. After 2020, the perpetual upswing in oil and gas production, a quick upsurge in grain yields, and tremendous reforms in the cogs (essentially iron ore) of the mining industry fuelled the continuous drop in commodity prices. In addition to the recent banking meltdown, the high inflation and peak interest rate period – ditto those eras. We have been in a world of rapidly evolving finances, with interest rates so downcast that it seems like we are hurtling toward a slow-moving banking crisis. Though for now, the Fed and the government have reduced the collateral damage from the SVB, banks might face pressure for years to come. Even the technology sector faces a reality check with slowing growth and regulatory scrutiny. 

Investment Ideas For The Decade

Thus under such circumstances, those willing to invest in commodities relative to financial assets may get outsized returns. As an investor, one can invest in indexes such as Invesco DB Commodity Index Tracking Fund DBC or the United States Commodity Index Fund USCI. Or an alternative would be to add some commodity stocks like Vermilion Energy Inc.VET, Barrick Gold Corporation GOLD, K92 Mining KNTNF, Albemarle Corporation ALB, and Skeena Resources Limited SKE that make an attractive proposition. 

Although we might be leafing through a new chapter of the US economy, there is a sense of pattern akin to previous history. With a recession looming just around the corner and the backlash of hiked Fed rates, market volatility remains persistent. Sporadic changes on the global front and internal factors such as tight money supply together draw forces to govern the thriving performance of commodity markets to S&P500.

 

Read similar articles from Alphanso here.

This content is for informational purposes only and is not intended to be investing advice.

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