Commodities Have Been Hot, Hot, Hot: What Are the Potential Implications for Investors?

Scan the global commodities menu and it’s likely many of the items you see are more expensive than they were a year ago. Copper, crude oil, lumber, soybeans, and several other commodities roared back from pandemic-driven slumps to notch multi-year (or even record) highs in recent months. Commodities have indeed been “hot” in 2021, and that could present long-term implications for investors and consumers.

For starters, the broad-based commodity rally is stoking inflation concerns, and higher commodity prices are raising input costs for businesses, according to Viraj Desai, senior manager, portfolio construction, at TD Ameritrade Investment Management, LLC.* Higher costs for those inputs eventually come home to roost, whether on a quarterly earnings statement or a consumer’s grocery bill.

“As demand for raw materials increases, the higher cost of production reverberates through the supply chain, ultimately hitting consumers’ pocketbooks in the form of more expensive goods and services,” Desai said. “As an investor, it’s important to look for signals from commodities on whether there are potential stress factors developing for businesses and consumers.”

What’s an investor to do? Here are a few basic commodity-related questions and ideas to consider.

Why Have Prices Been Rising for So Many Commodities?

Commodity prices, plain and simple, reflect supply and demand (or perceptions thereof). A year ago, the pandemic forced broad swaths of the global economy to shut down. But the rapid rollout of COVID-19 vaccines sparked a “great re-opening” that’s unleashed a flood of “aggregate” demand. In other words, demand is coming back in a big way: demand for steaks and burgers as people dine out more, demand for gasoline as people drive more, and demand for airfare as people travel more.

The broad demand upswing is reflected in many basic commodities used to power and feed the global economy. Futures based on copper and lumber (crucial inputs for homebuilders and other industries) recently notched record highs. For example, soybeans (a key ingredient in human food and livestock feed) recently traded at the highest levels since 2012, and crude oil is back above $60 per barrel, where it was trading pre-pandemic.

Is a New Commodity “Supercycle” in the Works?

Individual commodity markets over time move in “cycles” of high prices followed by cycles of low prices that may last a few months or a few years, at most. A “commodity supercycle” rally, by contrast, may last a decade or longer and usually includes, or is led by, many of the most heavily used and actively traded industrial commodities, such as oil, copper, and grains.

Some market professionals believe that just such a commodity supercycle is in its early stages, and they’re drawing parallels to previous supercycles that followed the ends of World Wars I and II. In a February 2021 report, JPMorgan Chase (JPM) analysts stated that commodity prices probably bottomed out in 2020, and “we likely entered an upswing phase of a new commodity supercycle.” But it remains to be seen whether the current trend becomes the first leg of a supercycle.

“Mostly, it will be the story of a post-pandemic recovery,” according to the JPMorgan report, citing other factors such as “ultra-loose” monetary and fiscal policies and U.S. dollar weakness.

One of the reasons we may be seeing a possible supercycle “is because short-term excess demand for raw materials is rising at a rate higher than supply is coming available,” Desai pointed out. Simply stated, as the world recovers from COVID-19, “demand is recovering faster than supply,” he added. Investors’ response to this outlook, in part, “should be predicated on how long you think that trend is going to last.”  

Why Is It Important for Investors to Keep an Eye on Commodity Prices?

Commodities are major inputs for many businesses. As commodities get more expensive, that can increase the cost of inputs and erode earnings. And remember: Almost anything can be a commodity and subject to supply-demand fluctuations: semiconductors, for example, and labor.

“Commodities are critical inputs for businesses at the front end of the supply chain, so when commodities get expensive, that has implications down the supply chain,” Desai explained. “Commodities can also signal whether there’s potential stress in the pipeline for businesses that rely on these raw materials.”

Sustained increases in commodity prices may eventually translate into higher inflation, which can erode the value of fixed-income investments, such as bonds. That’s why it’s a good idea to track inflation gauges, such as the Consumer Price Index and Producer Price Index.

What Are Some Ways Investors Could Access, or at Least Follow, Commodity Markets?

Commodity angles in the markets are everywhere. Futures trading is certainly not appropriate for all investors, but many commodity futures markets are highly liquid and global and trade nearly around the clock. Many are worth keeping an eye on, including crude oil, a major source of power in the global economy, and the most actively traded commodity there is. West Texas Intermediate crude oil (/CL) is the U.S. benchmark, while Brent crude (/BZ) is also widely followed.

Here are a few more commodities worth putting on your watchlist (along with their symbols on the thinkorswim® platform): copper (/HG), corn (/ZC), gold (/GC), lumber (/LBS), and soybeans (/ZS). For a broader brush look, check commodity indices such as the S&P Goldman Sachs Commodity Index ($SPGSCI) or the Bloomberg Commodity Index ($BCOM), which track prices for a number of commodities. Each index has a different weighting of the various commodity asset classes (energy, grains, metals, and so on). See figure 1.

If trading specific commodity futures markets isn’t for you, there are other avenues that offer exposure to commodities. These include exchange-traded funds (ETFs) and exchange-traded notes (ETNs), as well as “managed futures funds” that are overseen by certified professional traders.

There are also “commodity stocks”—miners, oil and gas producers, grain millers, and other companies directly involved in producing and processing commodities—as well as vehicles involved in very specific aspects of commodities (so-called Master Limited Partnerships that run oil and gas pipelines, for example).

Let’s not leave out the U.S. dollar, which can be tracked via the U.S. Dollar Index ($DXY). Major commodities are priced in dollars, so a strong dollar tends to be bearish for commodity prices, making it more expensive to buy grain or other commodities on global markets. Conversely, a weak dollar can be bullish for commodity prices.

Why Might Investors Consider Commodity-Related Opportunities, and What Are the Risks?

Commodities can be considered “alternative” investments, which hold certain appeal because these assets are supposed to be uncorrelated, or minimally correlated, with stocks and bonds—the idea being that if stocks make a big move lower or higher, alternative assets may move the opposite way—or at least not to the same degree as stocks. The potential noncorrelation to stocks and bonds is one reason alternative investments can help diversify your portfolio. Keep in mind, however, that diversification does not eliminate the risk of experiencing investment losses.

And here’s another thing about commodities: Things can change quickly and faster than you might realize. It’s important to recognize that commodity prices can be volatile and are influenced by weather and other factors outside anyone’s control and that a rally or slump can end seemingly as quickly as it began.

As Desai noted, the recent spike in commodity prices is broadly a function of demand outpacing supply. Demand is rapidly returning to pre-pandemic levels, while capacity to produce goods and services remains constrained. But eventually, producers will respond to higher prices, markets will do what markets will do, and supply will catch up with demand.

“Currently, demand for products and services is accelerating rapidly, while investment and production lag behind,” Desai explained. “The broader economy still has a way to go to recover from the pandemic. But as we make our way through the recovery, production will increase until supply and demand are more in balance. When you think about investing in commodities, it’s important to remember the laws of supply and demand still apply.”

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