Fynsa
Last week, we recommended increasing exposure to commodities, as geopolitical escalation has significantly increased the risk of further aggravating the energy and commodity crisis that has developed over the past two years. Potential disruptions to trade in oil, gas, grains, and metals now pose a significant risk to investments and the real economy. Investors should therefore hedge this risk by increasing allocations to commodities, energy, and materials. These allocations would serve as a hedge against inflation and geopolitical risks.
Well, this week we want to reaffirm our view of the advantages of adding commodities to a portfolio in the current environment and delve deeper into this investment thesis.From a strategic perspective, commodities are not only a geopolitical hedge, but also a hedge against inflation and against the valuation risk of changes in the reaction function of central banks.
And the case for diversification has rarely been stronger, with commodities up 40% year-to-date, half of that in the last week (as measured by the S&P GSCI Commodity Index), and equities down 8% (as measured by the S&P 500).
The case for investing in commodities has rarely been stronger, and the growing geopolitical tensions surrounding Ukraine have only strengthened the visibility of commodities. While the market is still working on a base case of limited disruption to food and energy flows (assuming that none of the economic interests of governments will use food or fuel as a tool to put pressure on Russia), almost all major commodity markets are in a state of severe depletion and are therefore highly vulnerable to even the smallest impacts. Furthermore, each disruption increases the likelihood of another revolt, with shortages in one market causing insolvency in another, as has been seen, for example, in the European gas and aluminum markets.
Although many commodities are fundamentally exposed to events in Ukraine, it is oil and gold that provide the cleanest hedges for this geopolitical risk. First, there is a clear upward bias in oil prices, both tactically and strategically, with any geopolitical risk premium exceeding the tightest inventory levels in decades, low spare capacity, and a much less elastic shale sector. According to Goldman Sachs estimates, if the oil market is forced to balance by 2022, a year ahead of its base case price of $105/bbl, the price of oil will have to reach $125/bbl to balance almost completely through demand destruction. The key relief point for a bullish configuration in oil would be an agreement with Iran, however, the geopolitical hurdles for this appear to be stubbornly high.
Similarly, it is clear that as geopolitical tensions rise, gold is acting as a currency of last resort, as gold tends to respond to geopolitical risks that may directly affect the US. Thus, the current energy crisis and above-target US inflation mean that any disruption to commodity flows from Russia could lead to increased concerns about excessive US inflation and a subsequent hard landing.
Currently, in our sector strategies, we are recommending exposure to commodities in two ways:
– In the US energy sector through the Energy Select Sector SPDR Fund (XLE) ETF.
– In the mining sector through the iShares MSCI Global Metals & Mining Producers ETF (PICK).
– Looking for a more direct alternative for exposure to commodities? A good option is the iShares S&P GSCI Commodity-Indexed Trust (GSG) ETF, which has 60% exposure to energy, 18% to agriculture, 11% to industrial metals, and 4% to precious metals among its largest exposures.
– For direct exposure to gold, one alternative is the SPDR Gold Shares ETF (GLD).
