Why invest in commodities
An undeniable alternative...
The opportunities for effective portfolio diversification are not limited to stocks, bonds and real-estate.
From a strategic perspective, commodities offer an ineluctable investment alternative on several levels:
- Attractive long-term returns, comparable to stocks and superior to bonds
- An opportunity for meaningful diversification with zero long term correlation to equities and bonds; performance which is particularly strong when portfolios need it most; and an asset class that improves portfolio efficiency
- Protection against inflation
- A liquid asset class
In contrast to the ’80s and ’90s, commodities are the asset class with the most attractive fundamentals for the next 10-15 years. The current cycle is supported by the a structural increase in demand from emerging economies which is occurring at a time of material constraints on the industry's ability to meet such demand. Furthermore, investors remain very much underweighted in this asset class
A structural increase in demande
Globalisation and the demise of communism have laid the foundations for a cycle of industrialisation and urbanisation of the world’s most populous nations - on a scale never witnessed in the history of humanity. Similar cycles in the past were associated with a dramatic and sustained increase in demand for natural resources : USA 1900-1930, Japan 1950-1960, and even South Korea 1970-1980.
China is well advanced in this cycle, while India is rapidly following in it’s footsteps. Already China is the world’s largest consumer of coal, steel, iron and aluminium, and the second largest consumer of oil .
There is further billion inhabitants spread across 17 countries in Asia, South America and Africa which are also on the road to industrialisation. Collectively, these nations consume more natural resources than India, Brazil and Russia.
Constraints on the industry's ability to meet this demand are significant
The barriers to discovering and exploiting finite resources are rising for a variety of reasons:
- new and unexploited deposits are increasingly located in emerging countries where political risk is high and/or infrastructure is limited
- permitting is more and more complex and lengthy for environmental reasons
- equipment and qualified personnel are in short supply
- there is a chronic shortage of new discoveries
Taken together, these result in a longer and more expensive development cycle (from discovery to exploitation).
Furthermore, commodity prices witnessed a period of decline in the ‘80s and ‘90s which caused investors to turn their back on the sector in favour of new technology investments, and engendered a certain amount of scepticism among management regarding the sustainability of higher prices which affects investments decisions. This is especially true following the collapse of prices in the wake of the 2008 credit crisis.
Elsewhere, in the case of non-finite soft commodities, there are physical limitations such as scarcity of arable land due to urbanisation and land degradation in addition to water shortages and increased competition for water from industry and hydroelectricity.
Four good reasons to invest in natural resources
- Natural resources have extremely attractive fundamentals over the next 10 to 15 years
- Investors remain largely underweight in this asset class
- Natural resources are beneficiaries of a reflation cycle
- The inclusion of natural resources in a portfolio increases its efficiency