Commodities: The Alternate Asset Class

The history of humanity’s ascent from a hunter-gatherer is tied closely to commodities. Grains were the earliest commodity, and the growth of early civilizations was driven by agriculture. The development of cultures is marked by the metals and alloys that were used, namely the Bronze Age, and Iron Age. Fossil fuels and their use led to the new era of modernization, and energy became an essential commodity.

Classification and types of commodities 

To this day, commodities are broadly classified into the three categories that we saw above.

• Agricultural commodities are mainly grains, sugar, coffee, and soybeans. Livestock and animal commodities including cattle, hogs, pork-bellies, and chicken.
• Metals and minerals is the second broad category. Metals themselves are divided between precious metals and non-precious or industrial metals. Precious metals include gold, platinum, and silver, while industrial metals include iron, copper, and aluminum. Minerals include rare earth elements such as Cerium and Yttrium and other minerals such as phosphates and potash.
• Energy, the third broad category, primarily includes  coal, petroleum, and natural gas.

Commodities role in the modern economy

Let us now look at the general uses of the various commodities.

Among metals, iron, copper, and aluminum are essential for modern manufacturing and construction industries. These three have various applications ranging from infrastructure, construction, automobile manufacturing, electrical appliances, precision machinery, industrial robots, and defense equipment. Copper is a bellwether metal for measuring the economic and industrial health of nations and is given the moniker “Dr. Copper” for its ability to identify turning points in the global economy. The electric vehicle revolution has increased demand for copper as it is used heavily in traction motors. Iron, especially its alloy steel, is a vital ingredient in manufacturing, and construction & building. Countries try to keep an eye on their steel requirements and industries as it is an essential asset. 

Precious metals have been used as a currency for millennia. Gold was a standard, and currencies were pegged to gold till the system was abandoned by the U.S in 1971. Gold continues to maintain its status as an inflationary hedge and a store of value. One segment of society still wants to peg currencies back to gold. Gold is also the preferred metal for jewelry. While also a precious metal, platinum finds industrial applications in catalytic converters for diesel engines, along with its cousin palladium. Silver has several industrial uses and finds itself in most modern electronics, including smartphones.

Among other minerals, cobalt and rare earth elements are used heavily in the modern electronics industry, especially in batteries. The rare-earth commodities are another industry area where the electric vehicle revolution has made an enormous impact.

Phosphates and potash are mined to be used as fertilizers. By volume, these are also some of the heavily mined minerals.

Agricultural commodities feed the world. Grains are used for both human consumption and as feed for animals bred for meat. Wheat and soybeans are the most widely grown and traded in this category. A large import/export market exists for agricultural commodities like grains. For instance, Russia is the largest exporter of wheat, while Brazil is the largest exporter of pork, with China its largest buyer.

Oil and natural gas are perhaps the most widely traded commodities. In addition to its use as fuel, petroleum and its derivatives are crucial ingredients in various chemicals, such as plastic, PVC, and reagents. Increased awareness about the effect of greenhouse gases has reduced the forecasted demand for fossil fuels. However, it is expected to be the dominant fuel source for the near future.

How to invest in commodities?

Commodities trade across the world both in the spot market and futures market. The futures market is more prevalent with a variety of commodities traded by both speculators and hedgers. Other derivatives such as options and forwards are also available on commodities. Some of the top commodity trading exchanges include the Chicago Board of Trade (CBOT), New York Mercantile Exchange (NYMEX), Shanghai Futures Exchange (SHFE), and Australian Securities Exchange (ASX).

Commodities are cyclical by nature, and their price movements are sensitive to supply/demand and the global economy’s health. A phenomenon known as the ‘Commodity Super Cycle’ exists whereby commodities follow a growth trend for a sustained period followed by a slump. Within this cycle, there exist mini-cycles of rallies and declines. The following chart gives a snapshot of this phenomenon in the last 20 years:

Source: Morningstar

Commodities are considered a separate asset class in investing. An allocation to commodity finds a place in most model portfolios. Commodities have a low correlation with other asset classes and, as a result, offer better diversification.

One could invest in commodities directly by using futures, but lot sizes are large there are requirements to monitor mark-to-market positions daily. Retail investors rarely use this route. Investors can also get indirect exposure by investing in mining companies that trade publicly in various stock markets. The better course for commodity investing is through commodity ETFs that track a single commodity like gold or copper, or a basket of commodities like energy.

See below a chart of the recent performance of a few commodity ETFs.

Source: Morningstar

Globalise customers now have the option to invest in a curated basket of commodity ETFs using the Diversified Commodity Globe.