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Some assets are harder to make yourself buy than others. Questor is convinced that our Wealth Preserver portfolio must be as diversified as possible if it is to achieve its goal and the assets we have in mind this week, commodities, are widely accepted as a diversifier, not to mention an inflation hedge. But still this column hesitates.
Why? The problem we have with commodities is that their prices are determined solely by supply and demand, both of which can be all but impossible to predict.
Easier to predict is their cyclical nature: when prices are low, the less efficient producers can’t compete and no one has any incentive to invest in new production, while low prices encourage demand. So prices rise. Higher prices encourage the discovery and exploitation of further sources, marginal producers become profitable, demand is stifled and so prices fall, and the cycle repeats. Cyclicality and wealth preservation make uneasy bedfellows.
To complicate matters further, we are at a point in history when some of the most established commodities of the industrial era are identified as the chief causes of climate change, while a host of newer materials are seen as essential ingredients of a low-carbon future.
How quickly these connected dynamics will play out and reflect themselves in the prices of particular commodities is anyone’s guess.
Set against all that we must acknowledge the weight of evidence for commodities’ value in inflationary times. For example, Bloomberg’s commodities index has shown strong correlation with the American consumer price index over recent decades.
And this is what Vanguard, the asset manager, has to say: “Financial markets expect a certain level of inflation and factor it into the asset prices they set, a condition theoretically neutral for investment portfolios. Unexpected inflation, on the other hand, can erode portfolios’ purchasing power.
“Do certain asset classes weather unexpected inflation, like we’ve seen recently, better than others? Recent Vanguard research suggests that commodities stand apart as a vehicle for hedging against unexpected inflation.”
It added that over the past three decades “commodities have had a statistically significant and largely consistent positive” correlation with inflation. One of its fund managers found that over the past decade commodities’ “inflation beta” has fluctuated largely between seven and nine. In English, this means that a one percentage point rise in unexpected inflation would produce a 7pc-9pc rise in commodity prices.
In the face of such evidence our portfolio must include some exposure to commodities. We have decided on 10pc of the total, split among four different commodities for further diversification. But which ones?
It seems sensible to steer clear of those most in danger from the move to decarbonise and favour those that are part of the solution to climate change.
Copper is one obvious candidate. JP Morgan Asset Management said in June: “Renewable energy systems can consume five times more copper than conventional energy systems, and the average battery electric vehicle consumes around 60kg more copper than a similarly sized internal combustion vehicle.”
Lithium is another thanks to its central role in batteries, and aluminium is a third. Lastly, this column thinks nuclear power has a part to play in the mix of carbon-free electricity sources.
We will put 2.5pc of the portfolio into each of these commodities via the following shares: Antofagasta (copper), New York-listed Sociedad Quimica y Minera de Chile (lithium), Yellow Cake (uranium) – all tipped by this column in the past – and the WisdomTree Aluminium exchange-traded commodity (ETC).
Yellow Cake and the aluminium ETC are at record highs, SQM is roughly where we tipped it in 2018 and Antofagasta is not far from the peak of its historic trading range, although it has fallen sharply since April. Hard though it may be to buy at these prices, we must hold our nerve on the basis that expensive things can easily get much more expensive in times of severe inflation.
Questor says: buy
Tickers: ANTO, NYSE: SQM, YCA, ALUM
Share prices at close: £14.76, $53.87 (at 5:45pm), 380p, $4.35
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