The first week of May, 2011, saw a broad commodities sell off, with commodity futures falling almost 7% and stocks linked to commodities down 5% from April 27, 2011 through May 5, 2011.1 Is this the end of the line for the bull market in commodities or just another stop along the way? Viewpoints caught up with Joe Wickwire, manager of Fidelity Global Commodity Stock Fund® (FFGCX), for his thoughts on the recent sell off, and what it may mean for investors.
What has been behind the recent sell off?
I think what we have been seeing recently has been a correction within the long-term, secular bull market for commodities that began in 2000 after commodities had been in a secular bear market for approximately twenty years. Commodities have broadly fallen about 7% off their high at the end of April. Corrections of this magnitude happen fairly often in the commodities space. We’ve now seen five corrections of 7% or more since the beginning of 2010.
In my opinion, the world and markets will probably continue to stay incrementally more volatile than most people would like and probably on an order of magnitude greater than what people have been used to since the 1980s.
In a world that today is still dealing with a great deal of uncertainty and has many different market participants who can have very dissimilar profiles and time horizons, I think it is useful to realize that violent swings—both to the upside and the downside (rallies and corrections)—could be part of the new normal. As I have stated before, I don’t think you should let short-term volatility alter your long-term investment program. The reasons articulated by “talking-heads” for each rally or correction are usually varied, are usually opinions versus facts, and are usually not all encompassing.
So how should investors react?
I believe that if you have a long-term investment strategy, very rarely do you need to actually “react” to any short-term market volatility. If anything, I suggest adopting a strategy or philosophy that embraces more volatile periods, like dollar-cost averaging or portfolio re-balancing, where extreme market movements can be an ally versus a foe. The process and philosophy that I utilize for my shareholders is set up to be opportunistic.
When markets correct, I personally will look to attempt to invest in tomorrow's outperformers at lower prices. I prefer equities linked to commodities—and given the breadth of the commodities asset class, there always seem to be a few segments that I find attractive at any given time. Recently, I have found opportunities in the energy sector, including supply bottleneck solutions like energy services and drilling companies, and in companies involved in building in expanding economies, like engineering and construction companies. I also think gold equities have still been well positioned due to macroeconomic imbalances, geopolitical tensions, and a favorable supply/demand profile for gold. Volatility also gives me an opportunity to evaluate the absolute and relative appeal of agriculture and food companies, base metal, bulk, steel, and paper companies, which recently have had less compelling profiles.
If commodities are so volatile, why would people invest in them?
It is these kinds of corrections that make it critical for investors to understand why you invest in the commodities asset class—and that you own it in the right amounts. Commodities and gold have always been volatile asset classes, and I believe that the world will continue to be more volatile and uncertain than in more recent economic cycles and than most investors anticipate. That’s why I feel commodities should be thought of as being a core, but small position in a portfolio for risk-tolerant investors. Commodities could have the potential to help provide diversification relative to the traditional components of an overall portfolio, namely stocks and bonds, and to help protect against a loss of global purchasing power. The latter is an important point that often gets overlooked. I think that the trend toward globalization has been acting as a deflationary force. As a result, some governments around the world have been fighting against that deflation with reflationary monetary and fiscal policies. Commodities and the equities of commodity producers, may help protect a portfolio against the effects those policies can have on one’s global purchasing power. In addition, the asset class can provide exposure to the growth of emerging-market economies, which have a greater degree of commodity-intense demand than some lower-growth developed economies.
Personally, I think it is worth considering commodity equities to gain exposure to this asset class. As attractive as a bar of gold may be, and regardless of the height of a corn silo, the commodities themselves don’t have the ability to generate earnings or cash flows, pay dividends, or discover new supplies. Companies that are linked to commodities do have these abilities, and when they execute, their equities may provide a return superior to those of the underlying commodities with the potential for of delivering a better "bang-for-the-buck."
So do you think this could be the end of the bull market for commodities?
The commodity bull market over the last ten years has been driven by both supply and demand—especially by the dynamic growth in emerging economies. And I think this backdrop remains in place, especially as the previous bear market in commodities lasted approximately twenty years. These long lasting secular moves within asset classes are quite consistent in history going back to the 1800s.
Some of these emerging markets have had a greater rate of economic growth than the more-developed countries, and have largely been unable to provide for their own growing need for food, fuel, shelter, infrastructure, telecommunications, and defense—the critical components of modern economies. It is important to note that in most commodities, supply-constraints have continued to maintain a tighter-than-expected supply/demand profile.
In a world that is struggling with deflationary headwinds that have come along with globalization, commodity production is one of the few businesses that actually has pricing power. I believe that the merits of having a small core position of one’s overall risk tolerant portfolio invested in the commodities asset class are strong and I would again emphasize that it should be owned for the right reasons, in the right amounts and built via a methodology that looks at market volatility as an opportunity versus an adversary.
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