As the economy expands and pushes up inflation expectations, investors may consider diversifying a traditional portfolio mix of equities and fixed-income assets with commodities and related exchange traded funds.
“Jerome Powell’s recent comments have sparked further market volatility, as investors face the potential of a fourth rate hike in 2018. Powell has expressed support for gradual monetary policy normalization, and despite the US dollar’s spike to a 5 ½ week high, the currency still faces uncertainty. Fed tightening, rising interest rates, and inflation have pushed investors towards asset classes that have historically hedged against rising inflation – particularly commodities,” Maxwell Gold, director of investment strategy at ETF Securities, said in a research note.
Supporting the current commodities outlook, a weak U.S. dollar has contributed to strength in the raw resources market as most commodities are priced in USD. The markets have attributed the recent bout of weakness in the greenback to the U.S. deficit, which has been exacerbated by the passage of the recent tax reform bill and expected fiscal spending plans out of the Trump administration.
“Overall this pick up in deficit spending paints a less rosy medium-term outlook for the US dollar,” Gold said.
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Furthermore, the ongoing economic recovery and positive growth outlook in foreign markets may drive investment demand to those markets, strengthening the local currencies of foreign markets at the expense of the U.S. dollar.
Meanwhile, some have interpreted the weakness in the U.S. dollar as rising inflation – a depreciating currencies means the spending power of consumers and investors also diminish. Current market expectations for U.S. inflation has also increased to over 2.1% from 1.7% in 2017.
“This has pushed investors towards assets that have historically provided a hedge against rising inflation, particularly commodities – which fared well in USD bear markets,” Gold said.
Consequently, investors interested in diversifying their portfolios with commodities exposure have a number of ETF options available to them, such as 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.
Furthermore, Gold argued that the commodities’ historically negative USD correlation may benefit the energy sector in particular, which has led the inverse commodity/USD correlation deeper after a brief positive relationship to the dollar in 2017.
Investors interested in energy-specific exposure can look to something like the ETFS Bloomberg Energy Commodity Longer Dated Strategy K-1 Free ETF (NYSEArca: BEF). BEF tries to provide long-term capital appreciation designed to exceed the performance of the Bloomberg Energy Index 3 Month Forward Index, which tracks movements in the prices of rolling positions in a basket of energy commodity futures with a maturity between 4 and 6 months.
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