Sinking Your FANGS Into Commodities

Investors Seek Alternatives as Inflation Concerns Rise

Inflation concerns are on the rise. Currently, frothy stock prices for growth and technology companies are leading many investors to search for alternatives. It should come as no surprise that many are considering commodities as a replacement for some of their FANG holdings. Commodities historically have performed well during periods of rising inflation and have demonstrated low correlations with equity markets (see charts below).

Note, however, that there are different fundamental price drivers for individual commodities. Therefore, diversifying among various commodities might assist the investor in building more resilient portfolios.   

Growth Losing Favor

The popular tech and growth names seem to be losing some favor with investors. Perhaps for good reason. Year to date the NYSE FANG + Index[1] has advanced 1.40%. Compare that to the 17.36%[2] advance for the GSCI Equally Weighted Commodity Index and its clear that the tech and growth names have lost a bit of their shine. 

Investors with whom we speak with have shared that they are increasingly turning to commodities seemingly for two reasons:

1. As a potential hedge against inflation

2. As part of a portfolio diversification strategy to ptentially help mitigate risk from stock market volatility

Inflation On The Mind

It is near impossible to have a conversation about the markets today without talking about inflation. The Barron’s cover story for the May 17^th edition was titled “Inflationary Explosion.” In the article, author Lisa Beifuss writes, “Inflation is here, say grocery shoppers, home buyers, manufacturers and retailers who insist their dollars are buying less.” Historically the perception that the “dollar is buying less,” has coincided with rising commodity prices.

The years 1972 through 1980 illustrate this point well. As you can see on the chart below, the Consumer Price Index (CPI) rose 267% during this time frame, and while commodity prices advanced 127%.

Data derived from Bloomberg Finance L.P. on 05/24/2021. All values as of December 31^st for referenced year. Included are: The Refinative Equal Weight Continuous Commodity Index (CCI Index), Consumer Price Index (CPI YoY Index), Spot Gold $/Oz (XAU Curncy), Corn Generic First Future Commodity Continuation (C 1 Comdty) Wheat Generic First Future Commodity Continuation (W 1 Comdty).

Gold was the star performer during this period. In the eight years ending 1980, gold gained 823% in dollar terms. Note that the United States formally abandoned the gold standard in 1972 which left the markets free to determine the value of gold priced in dollars. Presumably, the novelty of attempting to find a market price for gold provided a tailwind for the price advance. By 1981 gold prices were back below $500/oz. Gold did not reclaim the $500 level until 2005, some 24 years later.

Grain prices also performed well between 1972 and 1980. Corn prices advanced 144% and wheat prices gained 90%. Clearly the advance in grain prices was not as impressive as the advance for gold prices. However, there are fundamental differences between grains and precious metals. As such, there have been periods when grain prices outperform gold prices. In fact, year-to-date the GSCI grains index is outperforming Gold. See chart below:



Data derived from Bloomberg Finance L.P. 05/25/2021.

Year to date percentage performance of gold prices and the S&P GSCI Grains Index 12/31/2020-05/21/2021.

Past performance does not guarantee future results.

Fundamental Differences

Given the above historical context it’s not surprising to see commodity prices advancing while inflationary fears make headlines. However, before sinking your fangs into the commodity trade, consider that there are various fundamental factors impacting commodity prices and not all commodities are impacted by the same factors. 

For instance, food demand is a major fundamental factor impacting grain prices. Corn, wheat, and soybeans are primarily consumed as food either by livestock or humans. As the global population increases so too does demand for grains. In fact, global demand for grains has been growing rather consistently over the last 45 years (see the blue bars in chart 1 below).  Additionally, grain supplies are a function of grain production which is largely weather dependent. For example, droughts in the US corn belt have historically hampered production and contributed to higher corn prices. 

Contrast these fundamentals with gold. 

Gold is believed to be a store of value. Therefore, “investment” flows are a primary demand factor impacting the price of gold.[3] Gold supplies, however, are a function of production and demand. Gold production is not largely dependent on any one factor (whereas grain production is largely dependent on the weather), and gold demand has a higher level of variability compared to the grains. 

Clearly not all commodity prices are driven by the same fundamental factors. This reality is reflected in the chart below which shows individual commodity correlations to the S&P 500. 

You can see on the chart above that over the last 20 years futures prices for corn, wheat, soybeans, and sugar all have lower correlations to the S&P 500 compared to gold. Therefore, an investor may be able to create a more resilient portfolio by diversifying among multiple individual commodities.   

The Future

There is no guarantee that the historical relationships between stocks, inflation, and commodities will continue to hold into the future. The world is changing fast. The speed of innovation can seem dizzying at times. Since 1972 (when the US formally abandoned the Gold Standard) technological innovation has led to massive productivity gains and disrupted entire industries. While in the near-term it appears the FANG trade has lost some luster, sentiment is likely to reverse at some point with growth oriented investors once again setting their sights on the ever-promising future. 

Still, while a lot has changed since 1972, certain fundamental principles remain intact. For example, commodity prices are still subject to the law of supply and demand. Likewise, investors continue to look for alternatives to fiat currencies in hopes of protecting their purchasing power. Thankfully in 2021 it is much easier for an investor to express a market view than it was in the ‘70’s.  Gaining access to futures prices through an exchange traded product has made it possible for anyone with a brokerage account to take a position in a commodity like corn, for example. 

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[1] According to Bloomberg the NYSE FANG + Index is an equally weighted index designed to represent a segment of the technology and consumer discretionary sectors consisting of highly – traded growth stocks of technology and tech- enabled companies such as Facebbook, Apple, Amazon, Netflix and Alphabet’s Google.

[2] Year to Date percentage appreciation January 1, 2021 – May 21, 2021.

[3] https://www.statista.com/statistics/299603/gold-demand-by-sector/