Should you add commodities to your portfolio?
The outlook for many commodities is attractive, but “roll yield” can still be a headwind if you’re buying ETFs
Commodities spent much of the past decade in the doldrums, as the excitement about “supercycles” faded into a familiar boom-and-bust. In the aftermath of the pandemic, that’s changed: investors are getting far more involved in metals markets. Meanwhile, long-term commodity bulls are getting a favourable hearing as they set out a case for rising demand and tight supply caused by the electrification of the energy system.
Bulls can get carried away by this in the short term: copper is actually down by $2,000 per tonne since Jeff Currie was interviewed by Bloomberg. The dynamics look very complex right now. Chinese end-user demand is soft due to the weak economy (especially in real estate – construction uses a lot of copper). Yet Chinese copper stocks in warehouses have been building steadily and are at multi-year highs (that could reflect traders building positions in anticipation of a big government stimulus programme, which has so far not been forthcoming). That’s a large amount of metal that might be dumped back on global markets.
Miners have announced various production cuts and other supply disruptions. Meanwhile, smelters – who turn ore into refined copper – have added large amounts of new capacity in China and elsewhere, to the point where Chinese smelters have tried to coordinate production cuts because too many smelters competing for tight ore supplies has driven them into the red. Put all that together and it sounds a bit like a recipe for very volatile prices in the near term, rather than a one way bet upwards. Still, over the longer term, there is a strong argument that we have not invested enough in supply to meet future demand.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
What to consider when investing in commodities
However, it’s also worth thinking about how short-term price dynamics can affect your returns when you are looking for the right entry point. If you are trading commodities, you’re typically using either futures or an exchange-traded fund (ETF). The latter will in turn usually track an index of commodity futures. There are a few ETFs that hold physical commodities, but it’s a minority – mostly precious metals.
To keep a futures-based trade open for a while means rolling the position over into a later month as each contract gets close to expiry. If you are trading futures, you must do this directly. With an ETF, the index mimics this process. Either way, your returns are affected by the “roll yield” or “roll return” – the difference between the price of the contract you sell and the contract you buy. When near-term futures are higher than later ones (backwardation), you gain on the roll yield. When they are lower (contango), you lose.
Unfortunately, copper is in contango on the London Metal Exchange at present, as are many other metals. This indicates immediate needs are fairly well supplied (users aren’t rushing to secure supply). Note that this says little about the outlook – futures prices are not a reliable indicator of where cash prices will go in future! However, the negative roll yield might be a drag on returns if you’re buying commodity ETFs now.
This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
-
US election: Trump is back - what does it mean for your money?
Trump is back, but what does his election victory mean for your money and which stocks are tipped to do well?
By Kalpana Fitzpatrick Published
-
M&S smashes profit expectations on the back of strong food sales
Marks & Spencer’s half-year profits rose 17.2% to £407.8 million, well ahead of the £359 million analysts were forecasting
By Chris Newlands Published
-
Improved prospects for income investors
Income investors are raking in dividends, but it's not from the FTSE 100
By Alex Rankine Published
-
Is Brevan Howard Macro a good investment?
Holding Brevan Howard, a world-leading vehicle through an investment trust, offers diversification on the cheap
By Rupert Hargreaves Published
-
How can China boost consumption?
China's new policies may give consumption a cyclical boost, even if long-term gains require more serious reforms
By Cris Sholto Heaton Published
-
What is the outlook for oil prices?
Oil prices will be set by the face-off between Saudi Arabia and US shale producers. Could tail risks change the possible outcome?
By Cris Sholto Heaton Published
-
A fairer deal for investment trusts
New rules on how investment trusts report costs should ditch the idea that investors only need to look at one number
By Cris Sholto Heaton Published
-
Top global fintech companies to invest in
One British fintech hogs the headlines, but there are two top performers in the US. We explain where you should put your money
By David C. Stevenson Published
-
How Finseta is cashing in on currencies
Finseta has established a foothold in the upper echelons of the market for international payments. Should you invest?
By Dr Mike Tubbs Published
-
Top trusts that offer growth at a discount
Professional investor Alastair Laing picks three trusts where he'd put his money
By Alastair Laing Published