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Few sectors demonstrate just how volatile investing can be than resources – especially so far this year. Several commodities have experienced huge price swings in recent months, including oil and gas, base metals like copper and zinc, as well as lumber and potash.
“It’s been quite a ride for investors in the commodities sector,” says Doug Porter, chief economist and managing director at Bank of Montreal in Toronto.
“It’s definitely a more volatile sector than most others,” he adds, but notes that’s not necessarily a negative.
Commodities can act differently than other investments, Mr. Porter says, serving the role of “important diversifiers in a portfolio.”
That’s been the case in Canada, where the S&P/TSX Composite Index has seen less of a drop than the broad-based U.S. indexes year to date, due in part to our higher concentration of commodity names, which have mostly outperformed.
Globe Advisor spoke with Mr. Porter recently about his take on the commodities landscape and how advisors might want to approach the sector on behalf of their clients.
How do you characterize the year so far in commodities?
It’s been a tale of two worlds for commodities over the past six months or so. At the start of the year, they demonstrated a strong argument for why commodities have an important place in a portfolio. Then, the volatility of the past few months [and price drops in certain sectors] showed why a typical investor might want to shy away from them.
There are different stories about why some commodities have faded. For industrial metals, it’s because of global growth concerns. The more recent pandemic shutdowns in China have also hit metals demand. There’s also a lot going on in the agricultural sector, initially related to Russia’s invasion of Ukraine and, more recently, related to extreme weather in the U.S. and Europe. There are also different stories within energy as natural gas remains very strong, yet oil has been trading lower in recent months and is below pre-invasion levels.
What’s your outlook for this sector?
Commodities were seen broadly as a reasonable inflation hedge, partly because of their past performance. But I’d be cautious about making that recommendation in the near future.
Rising commodity prices have led to some bursts of inflation in the past. But the medicine now being used to cure inflation – higher interest rates – could hurt commodity prices, especially if that medicine works and undercuts global growth. Hopefully, central banks won’t have to go so far as to push the global economy into a downturn, but it’s a clear risk. The weaker the global economy, the worse it gets for commodities.
Of course, not every commodity is in danger. There will be a lot of separation among commodities in the coming year. But overall, I’d be cautious on commodity prices, generally, when central banks are on the inflation warpath.
What’s a common misunderstanding about investing in commodities that advisors should communicate to clients?
There are certainly times when investing in commodities makes sense, and those episodes can last years, but you have to be laser-focused on the cycle because conditions can change very quickly. Just as you can have years of them being on an upswing, you can have decades of a downturn. We’ve certainly seen that in recent history. So, you need to be able to tolerate long periods of underperformance.
Investors should also understand that they might have indirect commodity exposure through certain securities, such as railways stocks, which do better when commodity demand is strong [and vice versa]. It means ensuring you don’t have more exposure to commodities than you’re comfortable with.
This interview has been edited and condensed.
– Brenda Bouw, special to The Globe and Mail
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