For this week’s “ETF Report” on Yahoo Finance, with host Alexis Christoforous, ETF Trends’ CIO and Director of Research, Dave Nadig, was on hand to go over what’s happening with the billion dollars flowing into ETFs targeting natural resources. As he explains, there’s a good reason why it’s become so popular for investors, and it’s related to inflation concerns.

“I think a lot of folks are, at least, concerned about inflation,” Nadig says. “One of the ways people express that concern is by going into commodities. But commodities have all sorts of issues.”

For many investors, this is a new asset class that they are not particularly comfortable with. So, in addition to when commodities are rallying, the natural resource companies also get bid up. That’s what’s taking place currently. Many investors are putting money into equity markets but targeting inflation sensitivity through commodities, and that has worked.

Nadig continues, “Natural resources stocks are up significantly more on a year-to-date basis and a one-year basis versus broad market indexes, as investors really reach for that new approach.”

As far as any disadvantages go when pooling money into natural resource ETFs as a hedge against inflation, Nadig notes how this is still an investment in equities. Looking at the most popular fund, the Flexshares Morning Star Global Natural Resources ETF (GUNR), which owns a global basket of producers that are a part of the equity market. So, if there’s a giant drawdown in that market, they won’t be immune.

However, what investors are counting on is that these companies’ cash flow over the next 1-5 years will be outsized compared to how it’s being priced into the stock currently.

Nadig explains, “The disadvantage here is that you’re getting equities exposure whether you meant to or not. The advantage is that you are tying that equities exposure to something that’s more inflation sensitive.”

The State Of Continuing Interests

Given how great interest rates were for ETFs at the end of last year, it’s of little surprise to see this has continued. “Gangbusters” is the word of choice for Nadig, who notes how this year is lining up to deliver an absolute record, and if flows continued at the pace they are currently at, ETFs would be on track for something close to a trillion dollars in net inflows.

With that in mind, Nadig has a more modest projection of something around $650-700 million in net flows. However, that would still be the biggest year on record.

As for where investors are looking, inflation plays are definitely part of the story. There are major upticks in some of the commodity funds, Invesco’s PDBC has been very popular. Other inflationary-type assets have drawn interest as well, whether that’s gold or investors looking into rate plays such as senior and bank loans — anything that will deliver some upside.

Inflation Targets

Looking at recent statements from Jerome Powell, Chair of the Federal Reserve, who has stated inflation will be temporary, the market seems to feel differently. Nadig can agree on inflation being transient to a point.

“We’ve got these base effects behind us,” Nadig states. “The next couple of headline prints on CPI we’re going to see are going to be big. It’s not inconceivable that over the next quarter or two, we get to see a print over 3 on an annualized basis. However, that doesn’t mean it’s the new normal.”

He continues, “I think once we get past those base effects and get further into the fall, we’re going to discover that the economy has re-absorbed that momentum, and we’re probably back down around 2%.”

Much of this will depend on whether or not the Fed can hold onto a scenario that looks like an inflationary environment. It will lead to a lot of political pressure to do something (raise interest rates) as that inflation starts hitting.

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