Investing in Commodities: Why We Do It, and Why the Market Has Dipped in 2023

   By Andrew Steedman
   Investment Analyst
 
   June 15, 2022

Overall, 2022 was the worst year for financial markets since the Global Financial Crisis of 2007 – 2008. Last year was especially notable because both equity and fixed income securities had significant negative returns. My colleague Joe Halwax described this widespread volatility during our recent “Live from Wespath” virtual benefits education event for United Methodist clergy:

There was, however, one lone bright spot in the markets in 2022: commodities.

According to Investopedia, a commodity is “a basic product or raw material used to make all the goods and services that we need in our everyday lives.” These include energy sources like oil, heavy and precious metals such as gold and copper, and agricultural products like grains and livestock.

Last year, the Bloomberg Commodity Index, a commonly tracked basket of various commodities, returned over 16%. One of the key reasons for this positive performance is that commodities tend to work as an inflation hedge—when increased demand for consumer goods drives prices higher, the price of commodities, which are used to produce goods and provide services, usually increase as well.

Amid the elevated inflation witnessed throughout 2022—and exacerbated by the spike in energy and food prices after Russia invaded Ukraine in February—the asset class clearly had a solid year.

However, that trend has quickly reversed in 2023. Through May, commodities were the worst performing asset class in the financial markets, with the Bloomberg Commodity Index down over 11% year to date. By comparison, the Russell 3000 Index of U.S. stocks was up nearly 9%.

With this in mind, let’s take a closer look at the commodities market with the goal of answering two key questions: What has led to the negative performance of commodities in 2023? And what is the impact on Wespath? 

What’s Driving the Commodities Downturn

Commodity prices are influenced by a variety of factors, including supply and demand, economic growth, geopolitical situations, supply chains activities, and even Mother Nature.

We’ve seen several of these factors make a widespread impact on the commodities market in 2023, as each of the three primary commodity sectors—energy, metals and agriculture—have negative returns on the year. The three main drivers of this negative performance are the slowing global economy, a milder winter and an increase in commodity supply.

·        Slowing Global Economy: Commodity prices are typically impacted negatively when economic growth slows. As growth cools, there is less demand for goods and services, leading to a drop in demand for raw materials to produce those goods and services. Global economies have begun slowing down in 2023 after the U.S. Federal Reserve and other major central banks rapidly hiked interest rates in the hopes of controlling inflation. This general slowdown has led to growing expectations of a recession and a decline in demand for commodities, which has pushed their prices lower.

·        Milder Winter: The winter season from December 2022 through March 2023 was warm compared to historical temperatures and expectations, especially in Europe. Prior to this, there were fears of energy shortages in Europe—driven by Russia’s invasion of Ukraine—that could cause energy prices to balloon. However, the mild winter led to energy demand being lower than anticipated. Warmer temperatures meant less demand for energy resources to heat homes, leading to lower prices.

·        Increase in Commodity Supply: Russia’s invasion of Ukraine in February 2022 also had large impacts on the supply of commodities globally as both countries are significant exporters of energy, metal and agricultural products:

As mentioned, the invasion contributed to the commodities price spike last year. But since then, the world has adapted to make up for the supply lost from Russia and Ukraine. For example, the European Union has expanded energy imports from Latin America, the Middle East, West Africa and the U.S. This reconfiguring of global supply chains stabilized the supply shock from the Russia invasion—and actually led to an increase in commodity supply in 2023 that has driven prices down.

Percent Share of Global Exports (as of 2020, prior to the war)

(Source: World Bank – https://blogs.worldbank.org/developmenttalk/commodity-prices-surge-due-war-ukraine) 

What is the impact on Wespath?

Wespath has exposure to commodities through holding commodities futures in the Inflation Protection Fund – P Series and Inflation Protection Fund – I Series. Investors typically gain exposure to commodities through commodity futures. Investors don't want to own and store physical barrels of oil, for example. Commodity futures give investors exposure to commodities without having to hold the physical commodity. The FINRA website has more information on commodity futures. The funds have a 10% target allocation to commodities, and the strategy is managed by Gresham Investment Management, LLC. 

As a long-term investor, Wespath avoids making investment decisions based on short-term results and instead focuses on seeking above-benchmark returns over a long-term horizon. Wespath continues to believe that commodities serve as a valuable hedge to inflation in periods of rising prices, and we’ll maintain the 10% strategic allocation despite the recent commodities market volatility.

But this is a good reminder of our belief in the importance of active management and the value of selecting asset managers with expertise in their specific asset class. While we’ll stick to our long-term focus, asset managers like Gresham can make strategic decisions based on market dislocations to benefit from the changes in commodities. See the returns of the Gresham Commodities strategy compared to the benchmark, the Bloomberg Commodity Index, below:

Gross-of-Fees Commodities Futures Performance in P Series¹ (Gresham Commodities strategy)

Gross-of-Fees Commodities Futures Performance in I Series¹ (Gresham Commodities strategy)

Gresham has generated excess returns as a result of its underweight to industrial metals and overweight of livestock. In the P Series, in industrial metals we are underweight the benchmark by 4% and this has added .33% of excess returns. Those numbers are 3.6% and .32%, respectively, for the I Series. Our underweight to copper and zinc have helped the most. In livestock we are overweight the benchmark by 3% in both the P Series and the I Series. This has added .21% of excess returns in the P Series and .24% of excess returns in the I Series. Our overweight to live cattle and feeder cattle have helped the most.