Jan 20, 2017 - a prudent time to look to commodities to help diversify. Many ... Inflation may spur commodity prices ...
Maxwell Gold Director –Investment Strategy
Investment Insights
January 2017
The growing case for commodities Summary
0.6
Rising inflationary pressures may provide tailwind for commodities which historically closely track inflation. Recovery in global growth may also spur commodity demand driven by emerging markets and infrastructure spending.
Commodities: a key alternative investment for a challenging landscape A key contribution from holding commodities within portfolios stems from its diversification benefits. Historically, broad commodities have exhibited a low correlation to equities (both US and global) as well as fixed income (see Exhibit 1). Exhibit 1: Diversification benefits of commodities. MSCI World
Barclays Aggregate
0.4 0.3 0.2 0.1 0
-0.1 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Last year was certainly a turning point for the broad commodity complex, with the Bloomberg Commodity Index posting its first positive calendar year total return (+11.8%) since 2010. Prior to 2016, many investors approached commodities with disinterest and scepticism. While investor attention has been brought back to commodities amid price stabilization and improving fundamentals, the asset class should not be overlook as a critical component for portfolios heading in the year ahead with continuing changes to the investment landscape and geopolitical realm.
S&P 500
Bloomberg Commodity Index - Average pairwise sector correlations
0.5
Trailing 1 Year Correlation
Source: ETF Securities, Bloomberg.. Chart data from 01/03/92 to 12/31/1 6.
Historically, the correlation between commodities themselves has remained relatively low. In fact when evaluating the 5 major sectors of the Bloomberg Commodity Index, the average correlation of each sector pair has ranged from negative to about 0.5 at the peak during the 2008 financial crisis (see Exhibit 2). Amid the recent recovery in the commodity complex, this average pairwise correlation has dropped significantly (0.1) making now in our view a prudent time to look to commodities to help diversify. Many contest this lack of homogeneity among different commodities precludes its asset class status. This low correlation between other asset classes and among its constituents, however, only amplifies its unique position as a true asset class among other options.
Inflation may spur commodity prices
Commodities
Another key benefit from commodities comes from its sensitivity and strong positive correlation to inflation, which is more pertinent for 2017 as rising inflation is expected to continue (see Exhibit 3).
Livestock Precious Metals Energy
Exhibit 3: Headline inflation catches up to core inflation.
0.1 0.2 0.3 Correlation
0.4
0.5
0.6
Source: Bloomberg, ETF Securities. Commodities = Bloomberg Commodity Index and respective su b-indices. Exhibit data from 01/31/91 – 1 2/31/1 6. See disclosures for further details.
This low correlation stems from the fact that commodities are global assets driven primarily by varying fundamentals (supply and demand), geopolitics, and weather patterns. These distinct drivers lead to unique exposures beyond the key factors of financial assets like stocks and bonds. This is particularly relevant as both these asset classes remain richly valued and approach record levels.
2016
0.0
2015
-0.1
2014
-0.2
US Headline Consumer Price Index (CPI) US Core Consumer Price Index (CPI) US Producer Price Index (PPI) Final Demand
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 (0.5) (1.0) (1.5) (2.0) (2.5)
2013
Base Metals
2012
Agriculture
2011
Exhibit 2: Commodity sectors historically exhibit low correlations amongst each other.
2010
Amid heightened geopolitical uncertainty and stretched valuations in traditional assets, commodities may serve as a key alternative investment and source of diversification.
Per cent (%)
Source: Bloomberg, ETF Securities . Chart data from 12/31/1 0 to 12/31/16
1 Past performance is no guarantee of future results.
Precious Metals Outlook: Gold
Looking beyond the US, the global economic environment appears to continue its recovery. Growth as measured by gross domestic product will likely remain at depressed levels for developed countries compared to pre-crisis levels, while emerging markets will likely remain the global growth engine. Exhibit 3: Manufacturing and raw material shipping appear to have shifted course last year Baltic Dry Index (lhs)
Global Manufacturing PMI (rhs)
1600
53.5
1400
53 52.5 52
1000
51.5
800
51
600
50.5 50
400
Index lev el
Index lev el
1200
49.5
200
49
0 Sep-16
Dec-16
Jun-16
Mar-16
Dec-15
Sep-15
Jun-15
Mar-15
Sep-14
Dec-14
Jun-14
Mar-14
$1,350 $1,250
$1,200 $1,150 $1,100
$1,050 Jan-17
Jul-16
$1,000
Gold’s strength in 2016 (posting an 8.6% gain after a 3 year bear market) was overshadowed by the drawdown in Q4 last year leading up to the Fed rate hike in December. A lot of the fast money that entered the gold market amid 2016’s volatility has likely left as evidenced by a decrease in net speculative positioning in futures markets and exchange traded fund (ETF) redemptions since the election to levels witnessed pre-Brexit (see Exhibit 5). Further geopolitical volatility and market surprises may spur investor interest back into gold as a risk hedge. In our view, precious metals should first and foremost serve the role as a core risk management tool within portfolios. With an outlook of heightened market volatility, rising inflationary pressures, and growing policy uncertainty, precious metals are likely to continue to see investment demand rise. Additionally in an environment of lower expected returns and higher expected volatility across all asset classes, investors will need to look beyond the traditional means to achieve their investment objective. Exhibit 5: Many speculators in gold have come and gone 2,100 2,000
300,000
Global Gold ETF Stock (lhs) Net Speculative Positioning (rhs)
250,000
1,900 Metric tonnes
Source: ETF Securities, Bloomberg. Chart data from 11/1/1 4 to 12/31/1 6
As growth is anticipated to remain robust measures of global manufacturing and shipping may continue to rise. Recent manufacturing Purchasing Managers' Index (PMI) levels have risen throughout 2016 indicating an increase of industrial activity and production. Further the Baltic Dry Index, a measure of global shipping of raw materials, has seen a similar recovery in recent months (see Exhibit 3). This may point to further support of commodities as global demand for raw materials and inputs persists against higher industrial and economic activity.
Pr ice ($/ounce
$1,300
Source: Bloom berg, ETF Securities. Chart data from 01/01/15 to 01/20/17.
48.5
Dec-13
$1,400
200,000
1,800 1,700
150,000
1,600
100,000
1,500
50,000
1,400 0
1,300 1,200 Dec-14
Ma naged Money Gold Futures Contracts
Continued global economic recovery may lead to higher commodity demand
US Real Interest Rates (lhs)
Jan-16
Commodities, a key input cost for industries and products, historically move in tandem with inflation. A rise in both consumer and producer prices may continue to benefit commodity demand and add additional support prices globally.
Gold price (rhs) 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0
Jul-15
Inflationary pressures will likely continue rising driven by commodity prices and unwind from weak energy prices. Wage growth acceleration also threatens to be a key driver of inflation in 2017, as the US jobs market continues to tighten. Additionally, a renewed focus on fiscal policy and public infrastructure spending under a Trump administration may also spur higher inflation.
Exhibit 4: Strong start to 2017 for gold and broader precious metals complex
Jan-15
Over the last year, however, headline consumer inflation has risen from 0.7% to 2.1% as of December 2016 along with producer inflation. This brings headline inflation back in line with core inflation which has hovered near the 2% the Federal Reserve (Fed) target. We see a likely scenario where the Fed allows an overshoot of this target as it awaits continued signs of economic recovery.
As highlighted in the November 2016 Investment Insights, The real impact of rising rates on metals, a key driver for precious metals, particularly gold, are real interest rates (see Exhibit 4). Rising inflation, however, should keep real interest rates low even against a Fed rate tightening cycle. This would be a tailwind for gold which historically performs well when real US interest rates are negative and low (up to 2%) as it is sought as a store of value by investors.
US 5 Year Real Rates (%)
Rising inflation has been a factor investors have not dealt with since the onset of the financial crisis. Monetary stimulus from central bank quantitative easing programs and the collapse of commodity prices sparked sustained disinflation in the US and deflationary pressures globally.
-50,000
Jun-15
Dec-15
Jun-16
Dec-16
Source: Bloom berg, ETF Securities. Chart data from 12/31/14 to 01/20/17.
2 Past performance is no guarantee of future results.
Important Information The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results. The ETFS Silver Trust, ETFS Gold Trust, ETFS Platinum Trust, ETFS Palladium Trust and Precious Metals Basket Trust are not investment companies registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Trusts are not subject to the same regulatory requirements as mutual funds. These investments are not suitable for all investors. Trusts focusing on a single commodity generally experience greater volatility. Commodities generally are volatile and are not suitable for all investors. Trusts focusing on a single commodity generally experience greater volatility. Please refer to the prospectus for complete information regarding all risks associated with the Trusts. Shares in the Trusts are not FDIC insured and may lose value and have no bank guarantee. The value of the Shares relates directly to the value of the precious metal held by the Trust and fluctuations in the price could materially adversely affect investment in the Shares. Several factors may affect the price of precious metals, including:
A change in economic conditions, such as a recession, can adversely affect the price of the precious metal held by the Trust. Some metals are used in a wide range of industrial applications, and an economic downturn could have a negative impact on its demand and, consequently, its price and the price of the Shares; Investors’ expectations with respect to the rate of inflation; Currency exchange rates; interest rates; Investment and trading activities of hedge funds and commodity funds; and Global or regional political, economic or financial events and situations. Should there be an increase in the level of hedge activity of the precious metal held by the trust or producing companies, it could cause a decline in world precious metal prices, adversely affecting the price of the Shares. Should there be an increase in the level of hedge activity of the precious metal held by the Trusts or producing companies, it could cause a decline in world precious metal prices, adversely affecting the price of the shares.
Also, should the speculative community take a negative view towards the precious metal held by the Trusts, it could cause a decline in prices, negatively impacting the price of the shares. There is a risk that part or all of the Trusts’ physical precious metal could be lost, damaged or stolen. Failure by the Custodian or Sub-Custodian to exercise due care in the safekeeping of the precious metal held by the Trusts could result in a loss to the Trusts. The Trusts will not insure its precious metals and shareholders cannot be assured that the custodian will maintain adequate insurance or any insurance with respect to the precious metals held by the custodian on behalf of the Trust. Consequently, a loss may be suffered with respect to the Trust’s precious metal that is not covered by insurance. Commodities generally are volatile and are not suitable for all investors. Please refer to the prospectus for complete information regarding all risks associated with the Trust. Investors buy and sell shares on a secondary market (i.e., not directly from Trusts). Only market makers or “authorized participants” may trade directly with the Trusts, typically in blocks of 50k to 100k shares. Definitions: Bloomberg Commodity Index (BCOM) is a broadly diversified commodity price index. Futures contract = agreement traded on an organized exchange to buy or sell assets at a fixed price but to be delivered and paid for later. The US Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services. US Headline CPI includes all categories while US Core CPI excludes food and energy. Global Manufacturing PMI Index (PMI) is an indicator of the economic health of the manufacturing sector. US Producer Price index (PPI) measures the average change in selling prices received by domestic producers of goods and services. The Federal Reserve (Fed) is the central banking system of the United States of America. The Baltic Dry Index (BDI) is a shipping and trade index created by the London-based Baltic Exchange that measures changes in the cost to transport various raw materials. Brexit is an abbreviation for "British exit," which refers to the June 23, 2016, referendum whereby British citizens voted to exit the European Union. Gross Domestic Product (GDP) is the total value of goods produced and services provided in a country during one year. S&P 500 Index is a capitalization-weighted index of 500 stocks selected by the Standard & Poor’s Index Committee designed to represent the performance of the leading industries in the U.S. economy. Barclays US Aggregate (aka Barclays Aggregate) Bond Index is a broad-based flagship benchmark measuring investment grade, US dollar, fixed-rate taxable bond market. The MSCI World Index is a free-float weighted equity index developed to track developed world markets, and does not include emerging markets. Correlation is a measure of fluctuation between two variables. Pairwise correlation refers to the average correlation between all combinations of two distinct variables among a set of variables. Diversification does not eliminate the risk of experiencing investment losses.
Commodities generally are volatile and are not suitable for all investors. This material must be accompanied or preceded by the prospectus. Carefully consider each Trust’s investment objectives, risk factors, and fees and expenses before investing. Please click here to view the prospectus. ALPS Distributors, Inc. is the marketing agent for ETFS Silver Trust, ETFS Gold Trust, ETFS Platinum Trust, ETFS Palladium Trust and ETFS Precious Metals Basket Trust. Maxwell Gold is a registered representative of ALPS Distributors, Inc. ETF001097 1/31/18
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