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SAN FRANCISCO — U.S. equities outperformed commodities this year by a long shot, but commodities have a good chance to regain investor favor in 2014 after three consecutive years of declines.
"Something has got to give in 2014," said Phil Flynn, senior market analyst at the Price Futures Group in Chicago.
As the investing game draws to an end for the year, the near final score is: commodities down roughly 9%, based on the Dow Jones-UBS Commodity Index (.DJUBS). The Dow Jones-UBS Commodity Index Total Return Exchange-Traded Note (DJP)has lost 10% year to date. The S&P 500 Index (.SPX), on the other hand, has surged 25%, on track for its best year since 2003.
"Based off historical norms, either stocks are way too high or commodities are way too low. The odds are high for either a massive commodity rally or a rather large stock market selloff," said Flynn.
This year will mark a third year in a row in which commodities have underperformed U.S. equities. Including 2013, the Dow-Jones UBS Commodity Index has fallen for each of the last three years, as the S&P 500 Index scored significant gains over the past two.
"The biggest story in the markets in 2013 to 2014 is commodities against stocks as an asset class," said Flynn.
"There has been an under-investment in commodities and usually that has consequences," he said. "It normally creates an environment where tight supply emerges ... [and] the cost of production and the low prices mean we may not see the investment we need to meet demand."
So commodities and equities are poised for "some major moves in the coming year," Flynn said.
This year's action for commodity prices and equities was already one for the record books.
The DJ-UBS Commodity Index has never posted declines for three years in a row, based on FactSet data going back as far as 1991, and the S&P 500 Index is poised for its biggest yearly gain in a decade.
"It's difficult to compare to prior historical periods because commodities really hadn't become popular among institutions and retail investors until recently," said Arvin Soh, a portfolio manager at GAM, which has over $120 billion in global assets under management. Still, "it is often the case that sustained outflows are a contrarian indicator and indicate an improving environment."
This year has also seen commodity funds shut down or return capital and that's likely to happen next year as well, he said. That's "potentially positive because there is less capital invested in the space."
But the path for commodities can be "bumpy and outflows can persist for longer than one would rationally expect," Soh said. "Capital leaving the space will translate into a better environment, but it could still be quite some time before that occurs."
In the meantime, the year's action can serve as a good lesson learned about the need for investment diversity.
"While some may perceive equities as overvalued and commodities as undervalued on an absolute basis," Sal Gilbertie, president and chief investment officer at Teucrium Trading, said it's more important to "consider the relative value of the two asset classes."
"Investors are learning that commodities can act effectively to diversify a portfolio because they historically often tend to respond to different price drivers compared to equities," he said. "Taking some equity-based profits off the table while reallocating a portion of that money to commodities ... is a classic asset-allocation strategy."
Many portfolio managers are looking for investments with low correlation to their core equities portfolio, said Gilbertie, and "selected commodities fit that criteria, especially the major agricultural commodities and precious metals."
Sugar, wheat, soybeans and corn all have "long-term correlations to the S&P 500 that are lower than gold," he said, adding that it wouldn't be a surprise to see some money shift out of equities and into agricultural commodities and gold at year end.
Investors spent this year looking for a return on their investments and sometimes gave up a diversified portfolio strategy to find it. Next year affords them the opportunity to "rebalance."
"Investors have been sent on a 'quest for yield' by the central banks who are keeping interest rates at historic lows," said Chris Gaffney, senior market strategist at EverBank in St. Louis. "With equity markets posting great returns, many investors have given up the mantra of diversification in order to search for better returns," which is a dangerous move, he said.
"Commodities not only provide exposure to an alternative asset class, but they also provide a good 'inflation hedge' for investors," Gaffney said.
As with any investment, commodities certainly gave investors a run for their money this year.
Gold and silver were among the top decliners, while natural gas and orange juice topped the gainers. New York Mercantile Exchange-traded crude was ready for its first gain in two years.
Here's the rough breakdown of year-to-date tallies from FactSet as of late Thursday:
|COMMODITY (U.S. futures prices)
||YEARLY CHANGE (GAIN)
|1) Natural Gas
|2) Orange Juice
|5) Feeder Cattle
|6) Crude Oil
|COMMODITY (U.S. futures prices)
||YEARLY CHANGE (LOSS)
Overall, "equities have way outperformed and commodities have significantly under performed to the point of being tremendously out of favor," said Alan Konn, Price Asset Management's managing director of institutional sales.
That can be a good thing.
"As investors, our goal is to buy low and sell high," said Konn. "Some level of rebalancing into commodities from equities now appears prudent in 2014."
Still, he emphasized that his view is "not a call on the equity market direction — just that commodities have become relatively much more attractive."
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