Pimco’s real-return manager, Bransby Whitton, takes a closer look at the advantages of holding commodities in portfolios despite the asset class’s recent slump.

Investors typically look to commodities in order to provide three key benefits to their portfolios: diversification, inflation protection, and return potential. 

But for many investors, the return benefit of commodities has been difficult to grapple with amid challenging performance in recent years, and the relative performance of a portfolio containing commodities has varied over time, with periods of underperformance occurring during economic downturns.

Commodities as a whole are growth-sensitive assets, especially in recessions that coincide with plentiful commodity supplies and weak demand – exactly what occurred during the global financial crisis. Importantly, these periods were followed by years of recovery in commodity returns.

Commodities pick-up

Recently, correlations between commodities and other asset classes have subsided. They have returned to responding more to fundamental supply factors, including weather,which affects natural gas and grains prices, geopolitical instability, which influences crude oil, or mining strikes, which affect metals.

Importantly, these factors do not tend to affect stock or bond market returns to the same degree, and accordingly, correlations between commodities and other asset classes have come down. Recent correlations have also declined across individual commodities as the markets have come out of the global financial crisis.

The low correlation between commodity sectors currently stands in stark contrast to generally high sector correlations within other asset classes – equities for example. This is further evidence that supply fundamentals are once again taking over commodity returns, as each commodity is responding to its own idiosyncratic conditions, rather than to the effect of aggregate demand on the entire asset class.


Of course, commodities may still provide a valuable inflation hedge. After all, in terms of overall portfolio benefit, commodities should offer an effective means of helping hedge a portfolio against inflation shocks. Looking at the composition of the Consumer Price Index (CPI), food and energy make up approximately a quarter of the basket.

However, changes in inflation, especially unexpected changes, are driven primarily by food and energy.

Said differently, food and energy drive most of the CPI’s volatility. It is this unexpected volatility that is especially harmful to stock and bond returns. The commodity asset class, on the other hand, has a positive correlation to changes in inflation as it is the very same commodities comprising the asset class that drive the majority of CPI changes.

Furthermore, commodities tend to exhibit an outsize response to inflation, meaning that when inflation increases above expectations, commodity returns increase more than the change in the inflation rate.

So to the extent that inflation surprises to the upside, a commodity allocation can provide a potential hedge against inflation beyond just the original dollar amount invested.

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