Making a case that the stock market isn’t expensive these days often means dragging Tina into the conversation.
Tina is short for ‘There is no alternative’. It is a claim that after a decade of loose monetary policy and low interest rates, bonds, the traditional alternative to stocks, are no better a bargain than high-flying stocks.
Yet there may be one alternative to stocks. Commodities got cheaper through much of the second quarter, adding to several years of mediocre-to-weak performance. Gold and silver were hit hard. So were materials that work for a living, such as iron ore, copper, oil (and substances refined from it), although some of them staged rebounds late in the period, as did many agricultural products.
Ordinary investors can take positions in commodities through funds that hold them directly or that own shares of companies that mine, grow or process them. But should they? Prices have tumbled, but have they tumbled enough?
Investment advisers are divided on whether commodities are on the verge of reversing their poor performance, compared with stocks, and some who do think so aren’t especially enthusiastic about it. There is wider agreement that commodities or shares of production companies are worth owning for the sake of broadening a portfolio and reducing risk.
“The stock market as a whole looks expensive to us,” said Matt Kadnar, an asset allocation specialist for GMO, “but commodity stocks look like they’re trading at a bit of a discount, relative to where they have traded historically, and there’s a diversification benefit.”
“Having some element of your portfolio in commodity-based equities makes sense,” he said, “but it’s much harder to call them a strong buy, as you could have 15 months ago when they were being taken to the cleaners.”
That was around the time crude oil was trading at multi-year lows, in the mid-$20s a barrel, roughly half of where it is now. Agricultural products and industrial and precious metals were also near long-term bottoms.
Krishna Memani, chief investment officer of OppenheimerFunds, agrees that commodity producers’ stocks would have been a better buy then, but he still thinks they are worthwhile now and likely to perform well in the second half as evidence mounts of a broadening global economic recovery.
“As commodities have gone out of vogue, commodity-oriented companies are probably cheap, although I would have said that with a lot more conviction in the first quarter of 2016,” Memani said. “As the synchronised global growth picture persists, the discount may disappear.”
One reason Kadnar thinks shares of production companies have recovered less than they should have is that there is a bias against them that actually creates long-term value. “One of the things we like about commodity equities is that managers tend to avoid them,” he said.
Kadnar was hinting at a shortcoming inherent in investing in commodities: There are no correct fundamental prices for them. Yardsticks like price-earnings ratios exist to indicate whether stocks are reasonably valued, but commodities typically move, often with violent swings, in response to ephemeral and often unpredictable economic, industrial and even meteorological events.
Investors can work around those difficulties, said Scott E. Wolle, chief investment officer for global asset allocation at Invesco, by comparing recent prices with their long-term averages (most commodities are trading well below their average prices over the last 10 years, he noted) and choosing exposure to a broad range of markets, seeking diversification into and within commodities.
“That’s a long-term measure of value that should put you on the right side of the trade,” he said.
Exchange-traded funds with a diversified range of physical commodities include iShares S&P GSCI Commodity-Indexed Trust, PowerShares DB Commodity Index Tracking Fund and US Commodity Index Fund. The first two are heavily weighted toward energy commodities; the third has equal allocations of 14 commodities.
ETFs for production-company stocks generally focus on narrower segments, like SPDR S&P Metals & Mining, FlexShares Morningstar Global Upstream Natural Resources Index Fund and VanEck Vectors Agribusiness.
Commodities are useful in hedging against inflation, Wolle said. He acknowledged that inflation has been subdued worldwide for many years and that commodity prices have suffered for it, but they remain “one of the few assets that can protect you against that”.
Certain commodities, most notably gold, also serve as hedges against political uncertainty and upheaval, Wolle said. There certainly has been some of that in the last several months, and gold has rallied about 20 per cent from its low in late 2015.
With global monetary policy still loose, he recommends exposure to precious metals to guard against any uptick in inflation. The immediate outlook is also auspicious for industrial metals and energy, in his view, as economic growth picks up in more parts of the world, though he advises steering clear of agricultural commodities.
As for how to get exposure, Wolle favours the materials themselves, or funds that own them directly, rather than commodity stocks. Some companies hedge their own exposure by using derivative contracts that lock in a specific price for what they produce, limiting the benefit of rising prices, he pointed out.
The Wells Fargo Investment Institute, by contrast, favours a none-of-the-above approach when it comes to short-term allocations to commodities. It has been bearish since the start of the year and predicts weakness into 2018, in line with its bullish outlook on the dollar, which tends to move in the opposite direction from commodities.
But John LaForge, head of real asset strategy at the institute, conceded in a recent report that “the US dollar could make us wrong should it become unexpectedly, excessively weak.”
Noting that gold, an alternative currency for thousands of years, is more sensitive to movements in the dollar than other commodities, he added, “Gold is where we could be really wrong.”
Even if commodities bounce back, they may not bounce that high, Memani of OppenheimerFunds cautioned. “Commodities are probably in a good place, relative to the supply/demand dynamic,” but that “doesn’t mean prices are going back to the old highs” achieved around six years ago.
“People imputed special value to commodities based on the growth spurt from 2000 to 2007 driven by an investment and construction boom in emerging markets, and China in particular,” he said. “As that demand accelerated in a meaningful way, it helped prices, but that in turn brought in new supply and depressed prices. Unless we get a new boom, the chance of prices going back to that level is pretty small.”
It’s clear that commodities cost a lot less than they did several years ago and that stocks cost a lot more. But given the variety of opinions about commodities, it’s less clear they are the best of the alternatives that value-conscious investors look for, even if the others aren’t so great, either.
So investors should be careful when considering what, how and why to buy.
— New York Times News Service
