While the majority of the capital markets are anticipating rate cuts, certain economic data continues to run counter to the forecast. That’s why in times of persistent inflation, getting commodities exposure can be beneficial.
During the month of July, core inflation rose 0.3%, which marked the largest gain in six months. In times like now, inflation is proving to be stickier than anticipated. That said, investors will want to play defense with the right asset exposure. While there are hedging products like Treasury-inflation protected securities (TIPS), commodities can serve as a better counterpunch according to research from the Leuthold Group.
For the last five years, inflation has undoubtedly been a persistent speed bump. TIPS are typically an ideal defense mechanism when it comes to rising prices, but how well do they fare against commodities? In a five-year span, the consumer price index rose 26%, but during that same timeframe, TIPS (represented by the performance of a notable ETF) gained just 9%.
Compare that to the Bloomberg Commodity Index, which rose 110% in the same timeframe, outpacing inflation by a wide margin. Furthermore, they identified that a basket of commodities ETFs tracked well with the Bloomberg Commodities index two years after the Covid-19 pandemic in 2020, and have actually outperformed the index since late 2022.
“Our basket of commodity ETFs exhibited an amazingly close fit with the underlying index, proving their worth as protection against cost-based inflation,” the Leuthold Group noted.
A Commodities Pair to Consider
Given this, a pair of funds to consider are the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC) and the Invesco DB Commodity Index Tracking Fund (DBC). Both offer commodities exposure mainly from tracking the prices of futures contracts.
PDBC was one of the funds used in the Leuthold Group’s research, and rightfully so. It provides investors with a broad spread of commodities exposure, namely 14 of the most heavily traded. As such, exposure can range from oil, industrial metals, agriculture, and others.
Additionally, the fund is actively managed so PDBC’s managers can position the portfolio to capture upside in certain commodities. Likewise, they can mitigate risk in other commodities by limiting or eliminating exposure, allowing for a greater degree of flexibility compared to a passive fund.
Furthermore, the fund bypasses the need to issue a K-1 form. This is used for investors in certain limited partnerships and ETFs to report earnings, losses, or dividends on that particular investment. Instead, a 1099 form is issued, which passes along any gains from the fund directly to the investor. This makes reporting easier when tax season rolls around.
On the other hand, those looking for a passive option will want to look at DBC. It tracks the DBIQ Optimum Yield Diversified Commodity Index and, like PDBC, provides a broad range of commodities, and therefore, could serve as standalone commodities exposure in a portfolio to maximize diversification.
Avoid the Commodities Chase
Aside from inflation, one of the advantages of commodities is their portfolio diversification. It’s achieved by adding assets are that discorrelated from the stock and bond markets. To that note, it’s best to get this broad level of exposure as opposed to targeting specific commodities that are showing short-term upside.
“All of our commodities behave differently,” noted Kathy Kriskey, Invesco’s product strategist of commodities and alternatives during a VettaFi Alternatives Symposium. “They each have their unique fundamentals that are moving the prices.”
Kriskey confirmed that the best-selling commodities products are those that are broad-based. Getting broad exposure mitigates concentration risk when chasing one commodity. She used wheat prices as an example, which reached an apex during Russia’s invasion of Ukraine, but have fallen since.
“The biggest mistake investors make is chasing a commodity market,” Kriskey added.
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