Commodity ETFs may continue to find support as stronger investment demand coupled with the ongoing global growth could help the market gain momentum.
“High correlation to emerging markets coupled with rising investor interest may further drive commodity prices,” Maxwell Gold, Director of Investment Strategy with ETF Securities, said in a research note. “Supply may slow further as strengthening emerging market currencies raise commodity producer costs. Demand supported by infrastructure and consumer spending.”
Gold pointed to five factors that could help contribute to rising commodity prices, including emerging markets’ strong correlation to commodities, rising investor interest, stronger EM currencies, increased infrastructure spending and growing EM middle class.
The emerging markets are a major source of both supply and demand for global commodities. Over the past decade, the relationship between the benchmark Bloomberg Commodity Index and MSCI Emerging Market Index has risen to a 0.57 correlation from a 0.39 correlation over the past 27 years. With the global economy chugging along and emerging markets strengthening, more raw materials will be needed to fuel the growth.
The rising interest in EM exposure may also propel flows into commodity funds and assets, Gold said. Commodities may be seen as a cheap alter naive to EM, especially after the extended underperformance in the commodities space.
Strengthening emerging market currencies may also weigh on supply or exports to other countries, which in turn would help support pricing. EM currencies have appreciate on the weaker U.S. dollar, demand for higher yielding EM assets and recovery in EM growth.
With increased global growth, many economies are investing in their own economies through infrastructure spending, which may further increase demand for raw materials or commodities to fuel the build out. For instance, China could spend $950 billion a year on infrastructure projects while India is expected to expand its manufacturing share of gross domestic product to 25% from 17% by 2025.
Lastly, a growing middle class among emerging countries could raise demand for many agricultural commodities to meet growing populations, incomes and quality of life. Furthermore, with increased domestic product per capita, consumer preferences move up the consumption ladder from staples to discretionary to luxury goods, with the most common good substituted is grains for meat, which also requires greater inputs to cover.
Investors interested in diversifying their portfolios with commodities exposure have a number of ETF options available to them. ETF Securities recently came out with a line of ETFs to outperform the widely observed Bloomberg Commodity Indices without the need to worry about troublesome K-1 forms come tax season, including the actively managed ETFS Bloomberg All Commodity Strategy K-1 Free ETF (NYSEArca: BCI) and ETFS Bloomberg All Commodity Longer Dated Strategy K-1 Free ETF (NYSEArca: BCD).
BCI tries to provide long-term capital appreciation that exceeds the performance of the Bloomberg Commodities Index. It may not invest in all the components of the benchmark but will hold similar interests to those included in the index, along with short-term investment-grade fixed-income securities, money market instruments, certain bank instruments and cash or other cash alternatives. The underlying Bloomberg Commodities Index tracks the price of rolling positions in a basket of commodity futures with a maturity between 1 and 3 months.
BCD tries to provide long-term capital appreciation that exceeds the performance of the Bloomberg All Commodity Index 3 Month Forward Index, which tracks movements in the price of rolling position in a basket of commodity futures with a longer maturity between 4 and 6 months.
For more information on the commodities market, visit our commodity ETFs category.