Global financial markets have been very volatile over the past few weeks as the Russian invasion of Ukraine seems to be developing into a more serious affair than anticipated earlier. One consequence has been the outsize effect on the commodity markets. Russia is the third-largest producer of oil. Though its oil production has not been subject to the same level of sanctions compared to other areas of its economy, the perceived threat to Russian oil has nonetheless caused a spike in oil prices. Other commodities have also seen some wild moves recently, with nickel going up almost 250%.
Commodity markets are hard to predict as most of the underlying supply and demand dynamics are influenced by both long-term trends and short-term shocks. One wise method is to always have a small exposure to commodity as an asset class in one’s portfolio. In addition to the opportunity to add value, commodities are also less correlated to other asset classes and thereby improve the risk-adjusted return of the overall portfolio.
In the current scenario, one question on the minds of both investors and speculators is that are there more opportunities in the commodity space, or is it too late already. We can answer that with some historical context. The chart below shows a broad commodity index over the last 20 years.
One this evident in this chart is the fact that commodities can tend to follow a trend for extended periods of time. Some time periods include the long bull run between 2002 to 2007, the recovery from the global financial crisis in 2009 to 2010, and the mini rally in 2016 to 2017. The high peak from 2008 makes the rest of the moves look small, but they all were relatively large spikes in percentage terms. This can be seen in the following chart.
With this historical context, commodity rallies have typically offered opportunities beyond the initial spike.
The macro-economic conditions are also pointing to a mildly inflationary environment with a rate hike cycle imminent. Such conditions in the past have favored real assets and commodities along with broader equities.
The ETF universe offers several options to garner exposure to commodities as an asset class. Some of the popular ones include Invesco DB Commodity Index Tracking Fund (DBC), a fund tracking a basket of broad commodities, Invesco DB Oil Fund (DBO), an ETF that tracks the WTI crude oil price, Invesco DB Base Metals Fund (DBB) which tracks a basket of base metals, United States Copper Index Fund (CPER), a fund tracking the price of copper, and iShares Gold Trust (IAU), which tracks the price of physical gold. Apart from these, there are myriad funds that offer exposure to baskets of commodities, precious metals, specific metals, and the companies involved in mining many of these. ETFs that offer exposure to commodity-exporting nations could also play a valuable role. These include iShares MSCI Brazil ETF (EWZ), and iShares MSCI-Australia ETF (EWA).
The Russian invasion of Ukraine is the most aggressive military action to happen in the European region since World War 2. From the perspective of the capital markets too, this has been a dramatic event.
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