In a special St. Patrick’s Day-themed podcast, Matthias Scheiber, head of Global Portfolio Management, and Brian Jacobsen, senior investment strategist for Allspring’s Systematic Edge Multi-Asset team, discuss the risks, opportunities, and outlook for commodities.
Matthias Scheiber: It’s opportunity because it’s such a diverse set of commodities, which also means they’re also driven by very different underlying risk factors, which from the investor perspective, make them very interesting.
Brian Jacobsen: That’s Matthias Scheiber, head of Global Portfolio Management at Systematic Edge Multi-Asset for Allspring. I’m Brian Jacobsen, senior investment strategist for Allspring Systematic Edge Multi-Asset, and you’re listening to On the Trading Desk®. Welcome to a special St. Patrick’s Day-themed podcast. There are a lot of things that come to mind when it comes to St. Patrick’s Day, but one is a pot of gold at the end of a rainbow. Now, gold is a commodity, so we thought we’d take this occasion to discuss commodities. Thanks for joining me, Matthias.
Matthias: Thanks for having me, Brian. It’s always a great pleasure to be here.
Brian: Let’s start with something very basic. So, when portfolio managers think about commodities, what are they actually thinking about?
Matthias: Commodities are raw materials that can be bought and sold. They’re valuable, actually, for their use. There are some broad categories, like energy refers to things like oil and natural gas. Precious metals refer to things like gold and silver. Industrial metals have things in it like copper and aluminum. Agriculture is probably the broadest with things like corn, cotton, even live cattle. We monitor all the commodities at Allspring, but we tend to focus on the Bloomberg Commodity Index, sometimes simply refer to as BCOM. So, rather than being driven by macroeconomic events affecting one single commodity market or sector, the diversified commodity exposure of the BCOM potentially reduces the volatility or the risks in comparison with a non-diversified commodity investment.
Brian: As a portfolio manager, are you actually buying and selling these items?
Matthias: Rarely. I mean, most investment is nowadays done through futures contracts. They’re basically obligations to deliver or receive the underlying commodity. We don’t have to maintain warehouses or fields, but there’s also no necessity to take or make delivery. The spot price of a commodity, if you think of it, is the current cash cost of it for immediate purchase or delivery. The futures price, however, it locks in the cost of the commodity that we believe at some point other than present, usually some months in the future. So, if we want to price a commodity future, we have to take into consideration, obviously, the storage cost and the time value of money since the delivery is in the future. So, the futures price is the spot price basically adjusted for interest rates and storage costs. There’s also something called convenience yield. Think of it like a dividend yield. It reflects how valuable owning the physical commodity might be to pose as a collateral. Obviously, when interest rates and storage costs go up, everything else being equal, will tend to push up also the commodity future price relative to the spot price. So, future prices are complex as they include spot prices, but also interest rate, storage costs, and convenience yields.
Brian: Now when I look at a chart of some commodity indices, and those commodity indices as you said, those are just bundles of commodities futures, it looks to me like commodities kind of broadly fell during the COVID lockdowns of 2020. But then they made like a rainbow shape. At first, it was kind of this choppy recovery rising through the early 2022 invasion of Ukraine, but now it might look like we’re on that downward sloping part of the rainbow ever since perhaps May or June 2022. Can you tell us a little bit about what was going on to drive some of those price changes?
Matthias: Yeah, your statement’s absolutely fair, Brian. During the COVID lockdown, actually energy prices fell the most. Precious metals prices rose on the other side, so you saw the diversification within the commodity complex. Since then, they have been driven by various factors. Obviously, with central banks getting serious on inflation, precious metals have been range bound and volatile. Some precious metals have industrial demand, like silver, for example, while others are more viewed as a type of store of value like gold. So, they’re very different dynamics. Precious metals as a category were driven by the drop in demand for industrial uses of silver. But also, as rates rose, especially real rates, the attractiveness of cash increased and that lowered the relative attractiveness of alternative stores of value, like gold. From March 2020 to March 2022, industrial metal prices shot higher with industrial activity recovering and the supply chain staying clogged. But China’s zero COVID policy meant the outlook for the demand for these materials actually collapsed. So, the prices have staged a recovery since October 2022 when China announced an end to the COVID zero policy. Energy price on the other side, they have been affected by changes in the demand outlook and also by OPEC (Organization of the Petroleum Exporting Countries) and obviously Russia’s supply decisions. Energy prices peaked in June 2022 already when it looked like demand was likely to fall. Natural gas was particularly volatile as European economies rushed to stockpile reserves for winter. When the winter turned out much milder than feared, that obviously lowered the demand for natural gas and prices fell again. Agricultural prices, similar picture, peaked in May 2022. Ukraine is one of the biggest exporters of wheat to Europe and had a role to play, obviously, with the supply scarcity. Weather has also been a big driver, as usual, in agricultural commodities. There also have been supply issues with chickens getting sick, affecting egg prices, and a host of other more idiosyncratic factors impacting agricultural prices.
Brian: Matthias, when I think about commodities, two things come to mind. What are the risks, some of the fears around them, but then, of course, what are the opportunities? When I say commodities to you, what comes to mind first?
Matthias: It’s probably the opportunity because it’s such a diverse set of commodities you can think of, which also means they’re also driven by very different underlying risk factors, which from a portfolio perspective, an investor perspective, make them very interesting, not only from a return perspective because some of them are very volatile, which means they can also have very attractive returns, but also from a diversification perspective.
Brian: It really sounds like there’s a variety of different factors, risks, and perhaps opportunities in the commodity space. And so, what are your thoughts today about the outlook for commodities?
Matthias: It really depends on the specific commodity. In the category itself, it’s like a junk drawer rather than a pot of gold since there are a wide variety of items and the prices are driven by a diverse set of factors. That’s part of what makes commodities interesting in a portfolio context since they can bring in different risks, but also help diversify risks from additional assets like stocks and bonds. We might see short-term pressure on the commodity complex from higher real yields, as central banks globally continue to hike. Energy has been down 49% year-to-date, mainly driven by a sharply lower natural gas prices, which is the biggest weight in the energy sub index. That said, our indicators remain longer term positive on energy and to a certain degree, also industrial and precious metals. China reopening obviously has a big impact on commodity markets, which we have seen with the good performance of industrial metals late last year and early this year. Energy commodities remain also supported by higher demand globally and the limited supplies through the OPEC production cuts they implemented already last year to stabilize prices. Precious Metals, especially gold, could really benefit from a weaker dollar and the Fed (Federal Reserve) nearing the end of its rate hikes. The market tries to obviously anticipate the Fed pivot or when the Fed is done hiking interest rates and we have seen strong gains in gold so far this year. And we’ll also expect energy and industrial metals to come back once the clouds over the growth expectation and the interest rates path are much clearer.
Brian: Well, Matthias, thank you so much. That was incredibly informative.
Matthias: Thank you, Brian. It’s always a real pleasure talking to you.
Brian: Well, when you’re investing, may the wind be at your back and the road rise to meet your feet.
Matthias: Exactly.
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Disclosure: Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.
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