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15 reasons to back commodities

Cohen and Steers fund managers Ben Ross and Nick Koutsoftas believe the fundamentals are in place for the commodity recovery to continue.

15 Reasons to Take a Closer Look at Commodities

Ben Ross (pictured left) and Nick Koutsoftas (right), co-portfolio managers at Cohen & Steers, believe the fundamentals are in place for the commodity recovery to continue.

They write:

'Having troughed in early 2016, the supply-led commodity market recovery is well underway, with many commodity markets now balanced or in deficit.

'Demand for most commodities improved meaningfully in 2017, adding support for higher prices, as the Bloomberg Commodity Index climbed for a second consecutive year.

'We believe a convergence of macro, fundamental and secular drivers are aligning, providing the foundation for higher commodity prices in 2018.'

Koutsoftas and Ross draw on 15 charts to justify their view

 

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15 Reasons to Take a Closer Look at Commodities

Ben Ross (pictured left) and Nick Koutsoftas (right), co-portfolio managers at Cohen & Steers, believe the fundamentals are in place for the commodity recovery to continue.

They write:

'Having troughed in early 2016, the supply-led commodity market recovery is well underway, with many commodity markets now balanced or in deficit.

'Demand for most commodities improved meaningfully in 2017, adding support for higher prices, as the Bloomberg Commodity Index climbed for a second consecutive year.

'We believe a convergence of macro, fundamental and secular drivers are aligning, providing the foundation for higher commodity prices in 2018.'

Koutsoftas and Ross draw on 15 charts to justify their view

 

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1. Synchronised global growth

The global economy is running at its fastest pace in seven years and nearly all countries are feeling the lift, with 86% of purchasing manager index components accelerating, indicating a broad-based expansion.

In our view, synchronised global growth should stimulate additional demand growth for commodities.

 

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2. China hard landing risk has receded

While China’s economic growth is expected to slow in 2018 and beyond, we believe it should remain at a more sustainable level that is positive for both commodity consumption and global economic stability.

Upward GDP growth forecast revisions in 2017 and 2018 reflect the view of the government’s successful management of an orchestrated slowdown.

 

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3. Commodities have historically performed well in periods of unexpected inflation...

The market seems confident that inflation should remain low for the foreseeable future, leaving it vulnerable to a surprise. As global job growth continues, we believe upward pressure on wages could drive core inflation higher in 2018.

Commodities are often direct inputs to inflation measures and generally respond to the same forces that drive prices for other goods higher, including stronger demand from increased economic activity, as well as supply constraints. Commodities have historically been one of the most effective ways to hedge against unexpected inflation.

 

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4. ...and in rising-rate environments

Rising interest rates typically reflect strong economic growth and rising wage and price inflation—an environment in which commodities have performed well, historically.

 

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5. A late-cycle asset

On average, commodities have historically performed well toward the end of expansion cycles and in the early stages of recessions. While not a predictor of future returns, we believe this bodes well for commodities considering the US economic expansion is entering its ninth year.

 

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6. At the sweet spot of the fundamental cycle

The commodities supply-led rebalance continues following the trough in early 2016.

We believe many commodity markets are now balanced or in deficit and inventories are normalising, suggesting they are in the rebalancing (phase 5) or tightening phase (phase 6)—the sweet spot in the cycle.

 

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7. Oil rebalancing accelerated by OPEC/ non-OPEC production caps

OPEC and certain non-OPEC countries (primarily Russia) have adhered closely to their January 2017 agreement to limit supply, and recently extended it through the end of 2018.

This coordinated effort to remove nearly 2 million barrels of oil production per day has helped accelerate the rebalancing of supply and demand, helping to normalise global inventories.

 

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8. China supply-side reform and environmental cuts could expedite metals rebalancing

China’s supply-side reform began in 2015 and has included the shuttering of illegal capacity, environmental capacity cuts, waste import bans, and emissions controls.

These measures imposed by the government have restricted the supply of many commodities, including aluminium, zinc, copper and nickel, as well as many bulk commodities, and should continue to impact markets for years to come as policies are enacted to achieve the government’s targets.

 

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9. Elevated geopolitical risks

Conflict and political uncertainty can often disrupt supply chains for raw materials while causing volatility in financial markets.

With tensions escalating in many regions around the globe, owning commodities may be an effective way to defend against the effects of unexpected geopolitical events.

 

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10. Commodities at historic lows vs. stocks

Commodities are trading at their lowest price level relative to equities in over 25 years.

We believe the current market environment offers a historic value-driven opportunity to increase or initiate an investment in commodities.

 

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11. Back to backwardation

Backwardation—when investors will pay more for a commodity now than for delivery in the future—has returned for many commodities, signalling tighter inventories and a return to positive roll yield.

This could be a potential tailwind for commodities after years of detracting from investor returns.

 

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12. Correlations are generally back to normal

Years of global quantitative easing and sluggish growth have skewed recent correlations for many assets, including commodities.

But with the gradual normalisation of economic conditions, correlations are generally back to historical norms, reinforcing the diversification potential of a commodities allocation.

 

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13. Secular demand trends remain in place

While rarely talked about since the onset of the commodities bear market in 2011, significant megatrends continue to evolve that should impact the consumption patterns of commodities for decades to come.

These secular consumption-changing trends include population growth, urbanisation, higher per capita incomes and increased living standards.

 

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14. Electric vehicles—the newest megatrend

While there is certainly debate around the trajectory and timing of electric vehicle adoption, the implications for commodity markets are likely to be profound.

Bloomberg New Energy Finance estimates that we are on the cusp of exponential scaling in EV-related demand for industrial metals.

 

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15. The Belt and Road Initiative could boost infrastructure investment significantly

The Belt and Road Initiative is China’s vision for connecting the peoples of Asia, Oceana, Europe and Africa through a series of trade corridors and a maritime economic zone.

The effort will require massive investment in infrastructure, which should increase demand for metals such as steel, iron ore and copper, as well as power sources such as natural gas, coal and oil.

 

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