Commodity prices have been in a long-term downtrend while stocks have soared for much of the past decade. Given that we are twelve years into this bull run in stocks and historically asset class returns have always reverted to the long-term mean, one might ask: is this the time to buy commodities?
A major factor in the direction of commodity prices is the trend of the US Dollar because most commodities are denominated in Dollars. The Dollar has been in a long-term uptrend for much of the past decade but began weakening sharply last July. As the pandemic roiled the economy, fiscal and monetary stimuli acted to weaken the Dollar, and by extension boost commodity prices.
US Dollar Index (DX) 2-year Daily Chart
Commodity sector performance is principally driven by the forces of supply and demand. The pandemic has exacerbated price trends through supply shortfalls and stronger than expected demand across the global economy. One of the weaker sectors of the commodity markets over the past decade has been the grain markets. Since August we have seen a sharp change in trend; for example, the price of corn and soybeans have each risen by more than 50%. In addition, the El-Nino Southern Oscillation climate phenomena is currently in the La Nina phase which could intensify cross commodity asset volatility with increased yields in the Northern Hemisphere and reduced yields in the Southern Hemisphere. Only time will tell if these movements are transitory in nature or the beginning of a durable long-term trend.
Corn (C) One Year Daily Chart
Soybeans (S) One Year Daily Chart
To help put the potential opportunity in commodities into context, one can look at the ratio of the S&P GSCI Commodity Index (GSCI TR) in relation to the S&P 500 Index over the last 50 years.
- In the early 1970s, stocks were raging as the “Nifty Fifty” bull market was in full swing and the ratio of the S&P GSCI Commodity Index to the S&P 500 was well below 2.0x. The severe equity bear market of 1973-1974 followed, compounded by the Arab oil embargo, and the ratio of commodities to stocks reached nearly 8.0x.
- In the early 1990s, the US economy was mired in the Savings & Loan crisis and the first Gulf War, which sent crude oil prices soaring from $34 to $77 a barrel in a matter of months. The commodity to stock ratio peaked at just over 9.0x.
- Following the dot com bubble in the late 1990s, the commodity to stock ratio once again fell below 2.0x followed by the tech bust and accounting scandals of the early 2000s.
- The last peak in the commodity to stock ratio came during the Global Financial Crisis where it reached over 8.0x. Crude oil prices rose sharply in 2008, reaching an all time high of over $142 a barrel, on reduced supply and a weakening US Dollar.
S&P GSCI TR CME Index / S&P 500 Index – 50 Year Monthly Chart
As we enter 2021, and the twelfth year of the current bull market in stocks, the ratio of commodities to stocks is near the 50-year low level at 0.54. Historically such extremes have been corrected over time and often sharply. Investors with little or no exposure to commodities in their portfolios might consider revisiting the asset class, the sun is shining.