Lesser followed commodities, such as coffee, orange juice, cattle, cocoa and other agricultural markets driving increasing food prices have been the strongest performing sector in 2024. (Credit: Torsten Asmus/Getty Images iStockphoto files)
In the 1970s, the Goldman Sachs Commodity Benchmark delivered a cumulative 587 per cent, versus just 17 per cent for the S&P 500. The 1980s and 2000s also produced similar 10-year periods when commodities outperformed equities by a wide margin.
Each one of these bull markets had one, if not two, multiyear consolidations before the biggest move in the cycle; short-term corrections within a longer-term bull market. We believe we are rounding the corner on a similar consolidation within a commodity bull market.
There are always surprises in commodities. It wasn’t too long ago when investors were exuberant around so-called “energy transition” commodities. Now we look back, lithium, cobalt and natural gas are among the worst-performing markets in 2024. The long-term fundamentals are compelling, but timing is everything.
As we enter 2025, timing for these and other commodities may be opportune. The election result in the United States and the Republican platform are widely considered inflationary, with commodities a key component in this.
Protectionism, tariffs, energy security are policies that come at a time when cost-push inflation (when the cost of production increases, leading to higher prices for consumers), driven by wages, has already begun to creep back up. Central banks do not have a lever to control this by raising rates, as they do for demand-pull inflation (when the demand for goods and services is higher than the supply, causing prices to increase).
Indeed, so-called agflation has been increasing since the spring. While energy markets have corrected, the United Nations Food and Agriculture Organization’s Food Price Index, the global proxy for world food prices, has been increasing steadily since March.
We see many opportunities in some of these lesser-followed, but everyday-important commodity markets. Coffee, orange juice, cattle and cocoa, the agricultural markets driving increasing food prices, have been the strongest-performing sector, many making all-time highs again in 2024.
As we say often, “There’s a lot more to commodities than oil and gold.” Many smaller, emerging commodity markets have improving liquidity and offer increased diversification benefits given local supply and demand factors. Some of the agricultural markets, for example, were out of focus during the “Goldilocks” quantitative-easing period and didn’t have ample liquidity. That’s all changed in the past few years.
We see many opportunities in some of the transition markets: commodities such as lithium, cobalt and carbon emissions. Not only are these less correlated to other headline commodities, but they have come under significant price pressure. They could be great opportunities when the trend reverses and that could be soon, given the long-term supply-demand imbalances.
We are a rules-based trend follower, one of the differentiating factors in the way we invest versus other commodity fund managers. We rely on momentum, or price-based trends, to determine our position. Fundamentally, we’re bullish on natural gas; it’s probably our favourite market. But the trend is definitely down; hence, we’ve been short most of the year. Sometimes you have to go against your gut with commodities, like being short oil when it trades at US$10 a barrel as it did at the onset of COVID-19.
This year has been a tricky year for commodity fund investors and fund managers alike. While a couple of markets, such as gold and cocoa, have been strong, this has not been the case across the board. The main benchmarks, the Goldman Sachs broad commodity index (the S&P GSCI) and the Bloomberg Commodity Index (BCOM) are both flat year to date, and well below 2022 highs. Risk management — avoiding the steep, often unanticipated drawdowns — has been key.
In consolidation periods such as 2024, sometimes doing less is more. If you’re a more active commodity trader, you have probably been whipsawed a fair bit in the past two years. But it’s a trade-off. Agility and being reactive can pay off immensely, particularly at inflection points. Such was the case during the first half of 2020 as COVID-19 rattled markets, and during the first half of 2022 as equity and bond markets corrected alongside the Russian invasion of Ukraine.
Following two years of muted opportunity, we think commodities and CTA (commodity trading adviser) strategies will be a good place to be in 2025, and some of the biggest pensions are looking to position accordingly.
Institutional investors are adding significant exposure to their portfolio. Ontario Teachers’ Pension Plan, for example, is increasing its commodities weighting to 11 per cent, up from an already significant nine per cent previously. We are seeing the renewed interest firsthand: three institutional mandates — including two university pensions and endowments — in the last three months.
And by commodities, we mean direct exposure, as is the case with Teachers’, not resource equities. Direct commodity exposure via futures and CTAs historically have provided better diversification benefits as they tend to have much lower equity correlations than resource equities. Furthermore, the business, financial risk and overall high correlation to equity markets as a whole, associated with resources equities, can detract and do so significantly at times.
Consider gold mining exchange-traded funds, which are still trading at price levels experienced in 2006, whereas the spot price of gold has increased almost 400 per cent since then. And while there are positives that can be said about gold as a diversifier and store of value, it is not a great inflation hedge. After making highs in the summer of 2020, following the COVID-19 outbreak, gold traded sideways for three years, while broad commodity and CTA benchmarks delivered strong performance as inflation returned.
As for the long-term commodity outlook, we are broadly bullish on the asset class. It’s early in the cycle. Capital expenditures haven’t surpassed 2014 levels, and the energy and infrastructure demands are multiples of what they were a decade ago. But that does not mean commodities will go straight up. There will be ebbs and flows, just as we saw in the 1970s, 1980s and the 2000s. We think we may be entering the third or fourth inning of the cycle when commodities have historically outperformed equities by a wide margin.
After outpacing equities for two years starting in the summer of 2020, commodities have lagged equities considerably since then. Considered alongside equity valuations, with the S&P 500, for example, at near-record levels, the risk to reward may be compelling.
Rather than chasing returns, we suggest chasing good strategy, experience and disciplined risk management, for example, with an experienced fund manager or a CTA. CTAs have been around since the 1970s and broadly outperformed the long-only BCOM and GSCI commodity benchmarks by a wide margin, and also outperformed the S&P/TSX composite index. They have also done so with a fraction of the risk.
Since 1987, after the CTA category benchmark, the Barclay BTOP50 CTA, was launched, the S&P/TSX composite index’s worst pullback was -50 per cent and the BCOM -72 per cent, with the BTOP50 CTA a mere -16 per cent.
Today, amidst a correction, we feel commodities and trend-following CTA strategies are essentially on sale. Now may be an opportune time to rebalance out of recent equity strength and into tactical commodity strategies.
Tim Pickering is founder and chief investment officer and Brennan Basnicki is partner at Auspice Capital Advisors Ltd.
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