With equities still on a bull run like no other, it would be reasonable to say that commodities might not be top of the buy list for private investors.
But if you are looking for a slug of diversification to add to your portfolio there are three commodities that might attract the interest of savvy investors.
Top of the list is gold, which has had a fabulous run in 2019, returning 21%. That progress may not continue at such an elevated rate, but expect further appreciation.
Less keenly followed but definitely one to watch is precious metal palladium – which is now more expensive than gold.
And then there’s the wildcard play: rare earth minerals. In fact, the ores of the metals collectively known as rare earths aren’t actually that rare; rather, the deposits with high enough concentrations of the 17 rare earth elements to make it economic to mine are few. Recent moves in the US to secure a home-based supply chain prompt interest here.
We will come back to our three picks later. But first, what of other commodities such as oil and agriculture?
To begin with, some general considerations. Demand and supply for the stock of the commodity in question is the key consideration when trying to judge where prices are headed. The US currency is another moving part to bear in mind. We may be at peak strong dollar. Because many commodities are priced in dollars, any weakening in the world’s dominant reserve currency tends to raise commodity prices, most of which are priced in dollars.
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Energy prices on the back-burner
To make a call on what 2020 has in store for the oil price requires an assessment of the general direction of the global economy and how that impacts both industry and consumers as well as extraneous factors such as how the weather influences demand.
However, the latter is more a concern for traders as opposed to investors taking a longer view, so let’s concentrate on the other factors regulating supply and demand.
Although the non-OPEC US is the world’s largest producer of crude, it is the cartel-like OPEC that potentially has greater sway over prices in its attempts to co-ordinate cuts in production or to opens the taps.
On that front it has not had much success in flow regulation. According to the Bloomberg Commodity Outlook published in November, prices are expected to continue to trade in a range between $50 and $60, with bulls pressuring prices lower at the upper range of that band where price resistance forms.
Although stock markets could be set to power higher going into 2020 following the calming of nerves around the US-China trade dispute and the return of political stability to the UK, that doesn’t mean the global economy will deliver the sort of industrial production surge that could drive crude prices higher – or those of other cyclical commodities such as copper, stuck in a downtrend since May 2018.
JPMorgan Asset Management’s Year Ahead report thinks industrial metals will “stay neutral given sub-trend global growth”, citing China’s property sector as a key demand driver but where the government is “reluctant is ease current real estate restrictions”.
The effects of backwardation, where the spot price is higher than the forward price, should also bear down on the oil price, further stunting any bullish rallies.
JPMorgan underlines the possibility that “geopolitical tensions in the Middle East (Iran and Saudi Arabia, Syria) could result in episodic oil price surges in 2020”, but concludes that “softer demand growth and sufficient spare capacity globally should curb a sustained rise in oil prices”.
US production of natural gas continues to expand, so don’t expect any substantial price appreciation next year, regardless of the possibility of some improvement in global demand, especially from Asian emerging markets.
A key industrial input is copper and as such it is the commodity deemed most susceptible to the ebbs and flows of industrial activity.
Again, where the price goes is predicated on the direction of the global economy. Even though the trade war truce is bullish for copper and the US economy is still seeing healthy payroll growth, the situation in China remains far from encouraging, with GDP barely above the 6% required for the economy to maintain forward momentum – assuming you hold store in the accuracy of the official data.
Potash fertiliser demand set to rise
A quick word on agriculture. Prices have been trading sideways for key soft commodities that feed the world, such as wheat and corn. Cotton too hasn’t done much but that could change with better news on the US-China trade war front if the truce turns into lasting peace.
The largest agriculture ETF, Invesco DB Agriculture (DBA), is down 7.3% year-to-date and -8.8% over five years, having suffered falling returns since 2011.
A better way of playing agriculture could be the VanEck Vectors/Agribusiness ETF (MOO). It invests in areas such as fertiliser, animal health, seeds, irrigation, farm equipment and machinery.
It is trading up 19% as the year draws to a close. It is well-diversified but nevertheless has substantial exposure to fertiliser producers, which could see it benefit from trade peace.
“For 2020, we expect a full rebound in US acres planted and the recent recovery in palm oil prices to remain in place. Both factors should bode well for potash demand in 2020,” says data provider Morningstar.
Three commodity plays: gold, palladium and rare earths
The bright spot for commodities continues to be in precious metals.
Although gold has come off the boil recently, currently trading at $1,513 (on 30 December) after hitting a six-year high at $1,560 in early September, its safe-haven properties will likely still be in demand in 2020. The yellow metal’s prospects are helped by a continuing low-yield environment and the ever-present possibility of a resurgence in unconventional monetary policy intervention by central bankers and the continuing geopolitical risks emanating from the Middle East, Hong Kong and the likes of North Korea, to name but three hotspots.
And although political risk has lessened dramatically in the UK with the large Conservative majority in parliament, the same cannot be said for the US, which enters the presidential election year with its head of state facing an impeachment trial in the Senate.
Swiss investment banking giant UBS in its Year Ahead 2020 report is backing gold over cyclical commodities, echoing the reasons stated above: “Muted economic growth and now lower interest rates reduce the opportunity cost of holding gold, which does not offer a yield. Political uncertainty could send safe-haven flows into gold. And since gold is priced in USD, a weaker dollar would in turn push gold prices higher.”
The palladium market brings to mind the old investment adage “don’t fight the trend”. Since 2016, the price of the metal has been trending relentlessly higher, currently priced at $2,000 per troy ounce, making it more expensive than gold.
Two variables are at work here – highly constrained supply and rising demand caused by the ongoing tightening of regulations to reduce emissions from carbon-burning vehicles.
Tai Wong, head of base and precious metals derivatives trading at BMO Capital Markets, emphasises the fact that the normal scenario for commodities, where rising prices leads to an increase in production that pressures prices lower, does not apply in this market. “In most cases, the cure for high prices is high prices, but not for palladium,” he explains.
“There doesn’t seem to be any new, ready supply at any reasonable price. So, it could continue to move higher from here, though perhaps with more volatility,” adds Wong.
Palladium is used in catalytic converters and regulations on emissions are set to tighten further, with the replacement of carbon-burning vehicles by electric variants many years away.
WisdomTree Physical Palladium (PHPD) exchange traded product will cost investors 0.49% to hold and provides direct exposure to the metal, with HSBC bank the custodian of the palladium.
Our third commodity pick, Rare earths, are being used by China as a bargaining chip with the US in their trade dispute. China accounts for 80% of supply to the US and 70% of global production. The minerals are used to make key components in electronics for both civilian and military end users. There are 17 rare elements.
The US Army announced it plans to fund the processing of rare earths, an industry that was originally founded decades ago in the US.
The VanEck Vectors Rare Earth/Strategic Metals ETF (REMX) has been struggling this year but one way to leverage the US Army decision is by seeking those US companies lining up for a piece of the action.
One for the risk junkies – bitcoin
There is arguably a new entrant in the commodities world that warrants a mention – bitcoin.
Although touted as a digital currency, it is not used as such, or not very much. Instead, some see it either as a form of digital gold because of its supply being limited to 21 million (currently 18 million have been mined) or as a hedge against unconventional monetary policies.
Jan Van Eck, chairman and chief executive of ETF provider VanEck, leans towards viewing bitcoin as a hedge against central bankers. “It’s not exactly like gold [but] it’s a form of private money that will act as a hedge against central bank inflation,” he said in a recent Financial Times interview.
The reward that miners receive for doing the bookkeeping on the bitcoin blockchain will be halved in May 2020, a mechanism that kicks in every four years. Miners currently receive 12.5 bitcoins for each block they verify. This is the way that new bitcoins come into circulation.
Constraining supply in this way should lead to price appreciation. However, bitcoin is dominated by speculation so there is no certainty here, to put it mildly.
Add to those technical considerations working in bitcoin’s favour is the expectation of further geopolitical uncertainty ahead and the continuing absence of a full-blown recovery in the global economy.
But that won’t happen before the momentum from the stalled Facebook Libra crypto launch fully dissipates, with the price at the time of writing just above $7,000. Bitcoin’s Libra-induced high in 2019 was $13,700.