If all of this sounds familiar, it’s because it is. Many investors may be hearing about large gains made commodities investors. They may also feel locked out of previous markets and be searching for the next new thing. Both of those elements are common to what pushes investors to invest emotionally.
After a long season of volatility, many investors may be looking to diversify their portfolios. Commodities may seem like an option. Commodities are often brought up because they “at the crossroads of three of today’s biggest investment themes—rising inflation, a changing China, and the transition away from fossil fuels amid increased attention to climate change.” But is now the right time to invest in commodities? Your clients may think so. It seems like every time commodities enters the group chat, something major happens to make those investments more volatile than before. Case in point? The last time we discussed commodities was late in 2019, right before the pandemic hit. In 2022, the Bloomberg Commodity Index had its best year in more than a decade, rising more than a 25%. And then Russian forces invaded Ukraine.
Part of what may be driving the renewed interest in commodities is the inaccessibility of the real estate market. Before the pandemic, large institutional investors moved from investing in commodities like timber into real estate. The result was that the real estate market began to tighten immediately prior to the pandemic when supply dried up. Institutional investors also shifted from commodities towards REITs and EFTs of commodities due to regulation changes. New, stronger regulations for institutional investors concerning loss reserves may have moved those investors away from commodities. This is partially because with global climate changes, commodities no longer grow at a somewhat dependable rate. With many large investors dominating the real estate market, others may have been interested in traditional commodities.
Clients may be asking about investing in commodities now, specifically, because of how well commodities indexes have been doing. “The pandemic, by halting and then restarting supply chains, threw supply and demand fundamentals out of whack, and pushed many commodity prices up.” And that performance continued into the Spring of 2022. The Bloomberg Commodity Spot Index, which tracks 23 futures contracts, climbed 4.1% on a single day. That index tracks “prices of futures contracts on physical commodities on the commodity markets.” Other commodities besides petroleum and gas, like coal, cobalt, fertilizers, grains and seeds, precious metals like gold and titanium as well as industrial metals like steel and aluminum, were also impacted by the Russian war. Ukraine and Russia “also account for about 80% of global exports of sunflower oil.” The US price for sunflower seed oil had come to a crash in 2020, down from a five year high. Now it could skyrocket again.
Non-oil based commodities, like sunflower oil and grains, had been thought to be less responsive to market shocks. In a paper on how commodities responded to the COVID-19 pandemic, scholars found that “Our findings further show a high probability that commodity prices will remain in low volatility regime than in high volatility regime––owing to COVID-19-attributed market uncertainties. These findings are useful to both investors and policymakers––as precious metals and agricultural commodities show less negative response to exogenous variables.” Yet other scholars argue that the pandemic may have hidden a slow shift in commodities markets. “[A] half-dozen economists and analysts interviewed for this article …. said the pandemic may be helping mask structural shifts in commodity markets connected to the energy transition, or could in the future.”
If all of this sounds familiar, it’s because it is. Many investors, be they institutional ones or not, may be hearing about large gains made by those who invested in commodities. They may also be frustrated by feeling locked out of previous markets and be searching for the next new thing. Both of those elements are common to what pushes investors to invest emotionally – the habit of frequent selling of individual shares or asset classes or responding failing to move assets that have changed risk levels due to a fear of change. Advisors may want to listen their client’s interest in investing in commodities for notes of that familiar emotional investing tune.
These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.
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