April 23, 2018: Commodities In Current Environment

Apr 24, 2018 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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Commodities In Current Environment

In the recent weak stock environment, the strength of commodities does not go unnoticed. For example, recently, Jeffrey Gundlach, manager of the famed DoubleLine bond mutual funds, has been predicting an uptick in commodities’ prices for a while now. Let’s first take a look at their recent performance: 

Recent commodity trend

As of 4/20/2018, commodities have had one of the highest trend scores among major assets: 

Description Symbol 52 Weeks Trend Score
Commodities DBC 16.62% 7.22%
International Developed Stks VEA 18.33% 4.55%
US Stocks VTI 16.84% 4.47%
Emerging Market Stks VWO 19.1% 3.23%
Gold GLD 3.53% 1.28%
Treasury Bills SHV 0.9% 0.32%
Total US Bonds BND -0.14% -0.78%
US Equity REITs VNQ -7.15% -4.05%

Amid the weak performance of stocks and REITs, commodities have shown some unusual strength for the past several months. 

Among commodities, energy prices have risen the most while agriculture is the weakest: 

Commidity ETF YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR
DBE (PowerShares DB Energy ETF) 9.3% 25.7% -2.7% -10.1% -9.5%
DBB (PowerShares DB Base Metals ETF) 1.0% 23.3% 8.3% 2.9% -2.5%
DBC (PowerShares DB Commodity Tracking ETF) 5.2% 15.5% -0.7% -7.5% -7.5%
DBP (PowerShares DB Precious Metals ETF) 1.8% 1.1% 2.0% -3.4% 1.4%
DBA (PowerShares DB Agriculture ETF) 0.2% -2.6% -5.5% -6.0% -6.6%

Factors affecting commodities prices

There are several factors that can be attributed to affecting commodities prices. In the following, we list out the four significant factors. 

First, rising interest rates no doubt can have an impact on commodities prices. Regardless of inflation expectation or pressure (which so far has been benign but has shown some sign of picking up), rising rates make borrowing cost higher, which in turn pressures commodities developers (such as agriculture growers, miners etc.) to raise prices to offset the cost. Of course, one can also attribute this as the first sign of price inflation. As of today, 10 years Treasury bond yield has risen again to  2.97%, a hair away from the psychologically key level of 3%. 

Geopolitical events, especially in the Middle East and with Russia, have again made crude oil prices risen to a high level not seen since 2015.

In addition, the trade tension caused by the Trump administration’s trade policy only pushes commodities prices higher. With tariffs and import/export restrictions, businesses have to adjust prices (mostly higher). 

Finally, it’s often that commodities will rise in a late growth stage of a bull market or a growth period. In such a stage, profits have risen, wage pressure starts to show up, borrowing cost (interest rates) is higher. In fact, in 2008, we saw a similar picture: 

It was not until July 2008, DBC peaked and then started a sharp fall. Though we have no way knowing (neither we claim we can predict) when the next downturn will come, we do believe there is a strong similarity here. 

What to do 

Commodities have had a dismal performance in the current bull market. They now finally started to outperform other assets. It’s tempting to jump on the foray that suddenly attracts financial media attention. For example, it’s been widely reported that Gundlach predicted that commodities will outperform stocks in 2018. 

However, for those of us who are following a well-defined asset allocations strategy, one should treat these reports as just some information at best, noises at worst. 

For a Strategic Asset Allocation (SAA) portfolio, if the assets invested include commodities, you should just follow rebalance schedule. For those portfolios that have no commodity exposure, you shouldn’t change your portfolio on the fly. The key here is that SAA portfolios are for long-term (meaning 15 years or preferably 20 years or more). The current situation is just a blip in the long haul. 

For a Tactical Asset Allocation(TAA) that invests in commodities, you should understand that regardless of how well right now they are performing, commodities are very volatile and subject to all kinds of disturbance. You should rigorously follow the rebalance schedule in order not to be caught in a surprise, just like the sharp fall in 2008. For those who have no commodity exposure, we again don’t recommend adding such an asset on the fly. 

Market Overview

Last week, a worrisome sign emerged: even though companies have reported stellar earnings for Q1 2018 (based on Factset, the blended earnings growth is 18.3%, much higher than 17.3% expected in December 2017), company stocks fell mostly. It might be that the high earnings growth has been factored into the current stock prices. Or it might be that current geopolitical and trade tensions have had some major impact on investors’ sentiment. Or it could be due to now that bonds have higher yields, stocks have become less appealing. In fact, not only 10 year Treasury yield is breaching 3% level right now, short-term bond yields have risen markedly. While many bank deposits are still yielding close to zero, money market funds have now had a very respectable yield. For example, Vanguard’s prime money market fund is now yielding 1.8%. Regardless, the divergence between good news and bad stock performance is not a good sign for markets ahead. 

As always, we urge investors to manage their risk exposure to a comfortable level while sticking to planned and sound investment strategies.

For more detailed asset trend scores, please refer to 360° Market Overview. 

Now that the Trump administration has been in the office for more than a year, the economy and financial markets are in general still in a good shape. Whether the economy will continue to benefit from the supposedly trickle down of the tax cut, the deregulation, and the promised infrastructure spending remains to be seen.  On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in. 

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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