Commodities: A Closer Look at the Dynamics of Investing
Holding commodities in one’s portfolio will help to lower volatility-related risks
Chief Investment Office18 Aug 2023
  • July was a good month for commodities as easing macro conditions lifted prices
  • Negative roll yields have dampened commodity returns in the past decade
  • However, some Funds employ a “constant maturity” profile to minimise its impact
  • Commodities retains its all-important role as a portfolio risk diversifier
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Commodities rebounded in July on easing macro conditions. July saw a mini revival in commodities albeit in select pockets within the overall complex. The Organization of Petroleum Exporting Countries+ (OPEC+) and Saudi-driven production cuts finally started to have a material upward impact on crude prices, industrial metals such as copper and aluminum found some price stability thanks to de-stocking efforts in China, and agricultural commodities spiked again on port disruptions related to the Russia-Ukraine conflict. But perhaps more importantly, the overall macro environment for the US (and western Europe to some extent) appears to be trending towards a “goldilocks” scenario; the Fed is approaching the end of its rate hiking cycle, inflation is moderating, and GDP growth and unemployment have remained resilient. In essence, demand conditions for commodities are starting to look materially better.

Doubts over China demand caps optimism. The confluence of these positive factors drove strong performance for commodities for the month of July; the Bloomberg Commodities Index rose 5.8%, led by the energy sub-index which returned 11.4%. The agricultural commodities and industrial metals sub-indices also made gains of 2.1% and 6.4% during the month respectively. However, does this mean it is a good time to enter the market for commodities? We think it is still early days for a sustainable new rally cycle and macro conditions could quickly change. China, the world’s largest consumer of commodities, has yet to provide concrete details on how it intends to boost domestic consumption, and that will continue to cast doubt over the demand picture for commodities.

Undeniable function as a portfolio risk diversifier. While we do not advocate increasing holdings in commodities at the moment, we maintain our call for holding it as a risk diversifier within the overall portfolio construct given its low correlation with other major asset classes such as stocks and bonds. This low correlation is universal across multiple different timeframes across history as well. Over the past 30 years, broad commodities show a very weak negative correlation with global equities (-0.09) and a weak positive correlation with global bonds (0.17). In that regard, it is clear that holding commodities in one’s portfolio will help to lower volatility-related risks. What is unclear however, is whether holding commodities in one’s portfolio brings about a higher level of risk-adjusted returns; in other words, whether commodities reduce portfolio risk to a greater extent than returns are sacrificed. The answer to that question is up for debate, and the data will no doubt paint different pictures based on the time frame that is selected.

Figure 1: July’s commodity rally was largely led by energy

Source: Bloomberg, DBS


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