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Goldman Sachs loves commodities. You may want to at least like them.

The Wall Street investment bank argued in a research note this week that the case for owning the raw materials of the global economy has “rarely been stronger” than it is right now.

Not everyone agrees, of course. But investors fretting about stock-market turbulence and the punishing impact of rising interest rates on bond prices should take a look at the case for unloved commodities. These overlooked assets can diversify your portfolio, shield you against inflation and allow you to benefit from the late stages of a long-in-the-tooth economic recovery.

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The simplest case for them is this: They’re due. While Wall Street stocks have delivered a steady stream of pleasant surprises in recent years, commodities have brought nothing but pain – at least, until the past few months.

The commodities universe, which spans everything from oil and metals to cotton and pork bellies, has been the best-performing asset class of 2018, according to Goldman Sachs. As a group, raw materials have beaten the S&P 500 by eight percentage points since the start of the year and delivered a return of 7 per cent.

They still have room to run. In nearly every case, major commodities are still trading well below the prices they fetched back in 2014, when booming Chinese demand was propelling their values into moon orbit.

Of course, the reason they’re so relatively cheap today is the massive slump in commodities prices that followed the buying frenzy. As Chinese growth eased back, and wave after wave of new supply hit the market, commodities prices went into free fall. They hit bottom in early 2016, but not until many miners and energy producers had seen their share prices shrivel. This painful experience has “led to a high level of skepticism and hence an unwillingness to embrace the recent rally,” according to Goldman analysts led by Jeffrey Currie.

The Goldman crew believes investors should ignore the naysayers and load up. It’s not that commodities prices are going to rocket higher from here, they say, but that today’s relatively high prices are likely to persist. Following the collapse in market enthusiasm a few years back, miners and conventional energy producers stopped pouring money into new mines and wells. Sparse investment in fresh projects means there’s no surge of new production lurking in the shadows to overwhelm demand.

Oil prices will peak at US$82.50 a barrel in July and copper prices will hit US$8,000 a tonne in December, according to the Goldman analysts. They see both assets remaining elevated next year, with oil prices averaging US$70 a barrel and copper prices ticking in around US$7,800 a tonne. In both cases, the researchers see a significant chance of substantially higher values as demand continues to roar while new supply stays muted.

Other people also see emerging shortages. Moody’s Investors Service warned in a report this week that lack of investment in new mines means copper producers may not be able to keep up with growing demand for the metal from makers of electric batteries. Other battery metals, such as cobalt and nickel, could be in short supply, too, the credit-rating agency said.

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To be sure, not everybody is buying the bull case for commodities. Capital Economics, the London-based forecaster, says that economic growth in China, the major buyer of most industrial metals, is slowing down. The Asian giant’s declining pace of expansion will turn into a modest drag on metals prices, the researcher said this week at a conference in Toronto.

Capital Economics cautioned that much of the recent advance in commodities indexes was the result of rising prices for some agricultural goods. Lousy growing weather was the major culprit. Warmer, sunnier days could reverse the trend.

In keeping with its restrained outlook, the forecaster says the price of West Texas intermediate crude oil will sink to around US$55 a barrel by the middle of next year, while copper prices will ease back slightly to around US$6,600. Over all, it foresees a modest decline in commodities indexes.

It’s important to balance such downbeat takes against Goldman’s sunnier forecast. But even if your outlook for prices is less than exuberant, commodities still deserve attention because of their diversification benefits.

These physical assets tend to shine during the later stages of economic recoveries, as demand builds and overwhelms supply. Raw materials do much better than stocks during such periods, Goldman Sachs asserts. In fact, based on the evidence since 1984, Goldman calculates that investors should allocate as much as 80 per cent of their portfolios to commodities during times when the economy is slowing but not yet contracting.

COMMODITY RETURNS PHASES

Average asset returns by phase of global

business cycle, 1984 to present

Phase 1

Contraction

Phase 2

Recovery

Phase 3

Expansion

Phase 4

Slowdown

Below

capacity

& declining

Below

capacity

& growing

Above

capacity

& growing

Above

capacity

& declining

Relative ranking of assets

(average return by phase, annualized)

Bonds

12.2%

Eq.

20.3%

Comm.

29.7%

Bonds

14.3%

Eq.*

10.6%

Comm.

5.6%

Eq.

15.5%

Cash

5.6%

Cash

2.9%

Bonds

4.3%

Bonds

5.8%

Comm.

3.4%

Comm.*

0%

Cash

3.1%

Cash

5.1%

Eq.

-12.4%

*Eq.=Equities, Comm.=Commodities

CARRIE COCKBURN/THE GLOBE AND MAIL,

SOURCE: GOLDMAN SACHS GLOBAL INVESTMENT RESEARCH

COMMODITY RETURNS PHASES

Average asset returns by phase of global business cycle,

1984 to present

Phase 1

CONTRACTION

Phase 2

RECOVERY

Phase 3

EXPANSION

Phase 4

SLOWDOWN

Below

capacity

& declining

Below

capacity

& growing

Above

capacity

& growing

Above

capacity

& declining

Relative ranking of assets

(average return by phase, annualized)

Bonds

12.2%

Eq.

20.3%

Comm.

29.7%

Bonds

14.3%

Eq.*

10.6%

Comm.

5.6%

Eq.

15.5%

Cash

5.6%

Cash

2.9%

Bonds

4.3%

Bonds

5.8%

Comm.

3.4%

Comm.*

0%

Cash

3.1%

Cash

5.1%

Eq.

-12.4%

*Eq.=Equities, Comm.=Commodities

CARRIE COCKBURN/THE GLOBE AND MAIL,

SOURCE: GOLDMAN SACHS GLOBAL INVESTMENT RESEARCH

COMMODITY RETURNS PHASES

Average asset returns by phase of global business cycle, 1984 to present

Phase 1

CONTRACTION

Phase 2

RECOVERY

Phase 3

EXPANSION

Phase 4

SLOWDOWN

Below capacity

& declining

Below capacity

& growing

Above capacity

& growing

Above capacity

& declining

Relative ranking of assets (average return by phase, annualized)

Bonds

12.2%

Equities

20.3%

Commodities

29.7%

Bonds

14.3%

Equities

10.6%

Commodities

5.6%

Equities

15.5%

Cash

5.6%

Cash

2.9%

Bonds

4.3%

Bonds

5.8%

Commodities

3.4%

Commodities

0%

Cash

3.1%

Cash

5.1%

Equities

-12.4%

CARRIE COCKBURN/THE GLOBE AND MAIL,

SOURCE: GOLDMAN SACHS GLOBAL INVESTMENT RESEARCH

Most investors would be wise to avoid such extreme bets, but having at least a modest commodity exposure makes sense. If nothing else, commodities offer a hedge against inflation, which now appears to be picking up in Canada and the United States.

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How should you invest? The classic way is through the futures market, but very few of us should contemplate going this route: Buying contracts on a specific commodity is a high-risk endeavour that is best left to professionals.

A more accessible method is to invest through exchange-traded products that offer one-stop exposure to a wide range of commodities. A couple of U.S.-based examples include the iShares S&P GSCI Commodity-Indexed Trust and the PowerShares DB Commodity Index Tracking Fund.

The simplest strategy of all is to buy the stocks of major commodities producers. Many are relatively cheap compared with the rest of the market. Global miners such as Glencore PLC, Rio Tinto PLC and BHP Billiton PLC trade for multiples below the market average and offer generous dividends, typically around 4 per cent. The supermajor oil producers – BP PLC, Exxon Mobil Corp., Total SA, Royal Dutch Shell PLC and so on – provide equally tempting payoffs.

Just be aware of the volatility that goes hand in hand with commodities. The potential whiplash could be particularly severe this time around because of the highly political environment around many major raw materials.

The looming trade war between the United States and China, and Washington’s vexed relationship with Moscow, have already sent ripple effects through markets ranging from aluminum to soybeans to zinc. Meanwhile, the growing chaos in Venezuela and escalating tensions in the Middle East continue to shake oil markets.

All things considered, though, a modest tilt toward commodities at this point of the economic cycle makes a lot of sense. In a market where just about everything looks expensive, raw materials at least offer the advantage of being unloved and somewhat cheap. With little new production to offset healthy demand, they could at long last begin to offer some pleasant surprises.

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