Cohen & Steers: commodities can counter inflationary pressure

Commodities have delivered historically strong performance, offering inflation hedging, diversification and attractive returns, with the potential to contribute significantly to real asset allocation.

The Russian invasion of Ukraine has shone a spotlight on commodities as virtually every sector – from energy to agriculture to metals – has surged due to supply issues stemming from the war .

The longer the war drags on, the more likely supply disruptions will persist, with the possibility of lasting shifts in trade flows that could reshape commodity markets for years to come.

Long-term impact of the war in Ukraine

While direct sanctions have been limited so far, port closures, self-imposed embargoes and trade finance obstacles have directly affected the flow of goods from the region, affecting spot markets.

Even before geopolitical tensions reached boiling point, commodities had outperformed equities in this inflationary environment.

Due to the war, tail risks are, in our view, on the upside for commodities produced in the Black Sea region.

However, a decline in commodity prices is possible. Catalysts for a downturn could include: a de-escalation of the war, additional supplies of affected products, or a lower than expected final impact on flows of products produced in Russia or Ukraine.

The sharp appreciation in commodity prices in the face of this geopolitical and inflationary supply shock versus the reaction of traditional risk assets such as stocks and bonds is a stark reminder of why we believe commodities should be an allocation. strategy in a well-diversified environment. portfolio of real estate assets.

Even before geopolitical tensions reached boiling point, commodities had outperformed equities in this inflationary environment.

We believe the reasons for holding commodities in a portfolio of real assets – namely their strong inflation-hedging characteristics, diversification potential, and historical ability to deliver attractive total returns over full market cycles – are stronger than ever.

Commodities beat inflation

Unlike the slow and shallow recovery from the global financial crisis, which was characterized by deflationary globalization forces and insufficient demand, the fast and furious recovery from the Covid pandemic was characterized by inflationary anti-globalization forces and a insufficient supply.

Historically, commodities have outperformed traditional asset classes such as stocks and bonds in times of rising inflation as well as times of unexpected inflation

In our view, unprecedented levels of consumer savings and pent-up demand will continue to support economic growth and consumption.

At the same time, tight labor markets and failing supply chains are driving inflationary pressures on the supply side of the economy.

Since the second half of 2021, US inflation has surprised on the upside, with the consumer price index hitting a 40-year high in early 2022, and we believe a combination of strong demand and reduced supply indicate continued inflationary pressures with the potential to feed through to commodity prices.

Historically, commodities have outperformed traditional asset classes such as stocks and bonds in times of rising inflation as well as times of unexpected inflation.

In fact, even among its real-asset counterparts, such as resource stocks, real estate and infrastructure, commodities’ historical sensitivity to inflation is greater.

Why is that?

Commodities such as energy, grain, movable property, livestock, and metals serve as direct inputs to inflation measures.

Portfolio diversification is important, but it may become more so if the economy slips into a recession while inflation remains high

Commodities, which are commodities, also tend to react more quickly to economic forces – such as supply constraints and shifts in global demand – which often drive up the prices of other goods.

Commodities as portfolio diversification

In an environment of high inflation and rising interest rates, portfolio diversification may be more important than ever.

Commodities have distinct economic sensitivities that tend to differentiate them from stocks and bonds, particularly with respect to inflation and periods of growth.

And at a time when geopolitical tensions and potential supply shocks are high, factors that negatively impact asset classes such as stocks and bonds can positively impact commodities.

Historically, commodities have had a low correlation to global equities (0.42 from 1991 to the first quarter of 2022), adding potential diversification benefits to inflation sensitivity.

In this case, the low beta of the commodities market suggests significant diversification potential, helping to reduce portfolio volatility and, in our view, improve risk-adjusted returns.

Portfolio diversification is important, but it may become more so if the economy slips into a recession while inflation remains high.

we believe the risk of continued supply chain disruptions and tight inventories in many sectors is high

A look at the historical inflation-adjusted performance of asset classes relative to their long-term average – grouped by positive and negative surprises in times of economic growth and inflation – shows the potential importance of diversification of the wallet.

Attractive total return potential

A very favorable macroeconomic environment for real assets in general – and commodities in particular – developed rapidly, at a time when the supply and demand fundamentals for commodities were already favorable.

From a fundamental perspective, inventories of many commodities were at multi-year lows at the end of 2021, leaving producers scrambling to meet a resurgence in demand when Covid lockdowns were eased.

However, the lack of investment in supply in recent years means that ramping up production will take time. Ongoing Covid-related production issues, supply chain constraints and high electricity costs driven by the Russian-Ukrainian war only compound the low inventory situation.

In summary, we believe the risk of continued supply chain disruptions and tighter inventory across many sectors is high.

A multi-strategy portfolio of real assets

Commodities are one of four main asset classes typically included in a real asset allocation. The others are real estate, infrastructure and resource stocks. Together they form the “four main” categories of real assets.

The resurgence of global inflation – not seen for more than 40 years – is pushing investors to take a closer look at their asset allocation

Within a multi-strategy portfolio, real assets are typically used to achieve three goals:

  • Deliver outperformance in times of inflation
  • Improve risk-adjusted returns through diversification
  • Sustain strong returns over full market cycles

Historically, no real asset has excelled on each of the criteria of inflation sensitivity, diversification potential and total return.

Commodities, for example, have historically performed best in the areas of inflation sensitivity and diversification, while real estate has historically produced relatively consistent attractive total returns.

While many investors allocate to each of the four main categories individually, a turnkey real asset solution that strategically and tactically invests in all four has the potential to overcome the tradeoffs of standalone real asset exposures and better capture the attributes positive real assets.

The resurgence of global inflation – unseen for more than 40 years – is prompting investors to take a closer look at their asset allocation.

Excessive exposure to traditional risk assets such as stocks and bonds, which excelled in the previous decade of disinflation, seems unlikely to provide the inflation protection, diversification and return profile that investors expect. got used to.

This new world order, marked by high inflation, rising interest rates, de-globalization, tight labor markets and heightened geopolitical risks, has rekindled investor interest in commodities.

Ben Ross is Raw Materials Manager at Cohen & Steers

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