Shades of Bearishness
Commodities as later cycle portfolio components
2014 should be another relatively challenging year for commodities. Although the macro outlook appears to be improving, cyclical, fundamental and FX factors all point to another difficult year for spot price performance. Nevertheless, Morgan Stanley sees opportunities within the broader complex, but investors will need to remain selective and nimble.
By Adam Longson
IS THIS THE right time to be invested in commodities? The rally in the major commodity indices over the past two months has prompted questions about whether now is the time to be reallocating funds towards commodities. Although the asset class can provide some much-needed diversification, and even yield opportunities, for a long-only portfolio, we believe it is still too early in the business cycle to overweight commodities. While commodity alpha strategies remain attractive, commodity beta, or spot price performance, is likely to remain
... despite an improving GDP outlook, commodities are unlikely to outperform in 2014
lackluster. The asset class is inherently late cycle, and we see few signs that important late cycle indicators will emerge in 2014. In fact, much of commodities’ strong start to the year can be attributed to shorter- term weather and geopolitical fears, not improving macro fundamentals or a late cycle transition. We still see a place for commodities in the portfolio with the right strategy. The inherent
Commodities Tend to Outperform Later in the Business Cycle
(Annualized average monthly total return by cycle phase, Jun 1972 – Sep 2013, %)
10% 15% 20% 25%
-25% -20% -15% -10% -5% 0% 5%
21.5% 14.1% 11.0% 6.6% 18.9% 15.6%
20% 40% 60% 80%
-60% -40% -20% 0%
Expansion (Early)
-19.1% -18.9%
Expansion (Early)Expansion (Late) Recession (Early) Recession (Late) S&P 500 TR (Equities)
SPGCCI TR (Commodities)
SPGCCI TR (Commodities) SPGCGR TR (Grains)
SPGCIN TR (Base Metals) Sources: NBER, Bloomberg, Morgan Stanley Economics, Morgan Stanley Commodity Research 10 March 2014
SPGCEN TR (Energy) SPGCLV TR (Livestock)
SPGCPM TR (Precious Metals) Expansion (Late)
Recession (Early)
Recession (Late)
nature of the asset class provides some diversification, alternative factor exposure and tactical allocation opportunities at various points of the business cycle. However, with spot returns challenged, roll yields will likely be the key driver of returns. Similarly, investors can use commodities to generate bond-like income without duration risk by taking advantage of curve structure (i.e. backwardation) in certain commodities. Systematic commodity alpha or absolute return strategies are also attractive and tend to be more effective than similar strategies in other asset classes. Lastly, with beta challenged, idiosyncratic fundamentals have become more important and still allow for plenty of alpha capture, particularly for more active investors. As we look to 2014, we see a number of important fundamental themes for commodities. 1) Global growth is improving, but the composition of growth is shifting.
2) Commodities’ late cycle nature means it is still too early to overweight the asset class.
3) Global rebalancing makes DM and consumer- linked commodities better positioned.
Energy & Base Metals Tend to Perform Better in Late Expansion
(Annualized average monthly total return relative to equities, Oct 1986 – Sep 2013, %)
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