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What is a commodities super-cycle?

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A commodities supercycle or boom is a period of sustained and continued expansion due to increased demand for goods and products. Such supercycles are driven by economic growth and demand for energy sources, manufactured materials, and raw materials.

In-Demand Commodities during a Supercycle

Commodities that are in high demand include natural gas, coal, crude oil, aluminum, copper, and iron ore.

Natural Gas and Oil

Natural gas is used to manufacture iron, steel, bricks, glass, and paper. It is also used by utilities companies for electricity generation and by the commercial sector for metals preheating, incineration, and waste treatment. Crude oil is refined to produce diesel, jet fuel, and gasoline which are used to power equipment and for transportation.

Global political tensions, conflicts, and sanctions as in the case of the Russia/Ukraine conflict push up natural gas and oil prices. Gas prices have already doubled while oil prices have recently reached $139 a barrel, the highest we have seen in about 14 years.

Russia is the world’s biggest exporter of natural gas and the second biggest crude oil exporter. If one country relies on Russia for gas and receives less, it has to find an alternative source, thus impacting supply elsewhere.

Industrial Metals

Coal is used by steelmakers to produce steel and by utilities companies to generate electricity. Aluminum is a key component of airplane parts, electrical transmission lines, window frames, and other goods. Copper is used as a construction material for plumbing and roofing and for the manufacturing of industrial machinery and electrical equipment. Iron ore has many applications such as manufacturing catalysts, auto parts, magnets, and steels and construction of bridges and commercial buildings.

Demand for industrial metals has been high during all commodities supercycles. In 2008, for example, China’s demand for industrial metals, including aluminum, coal, and steel, resulted in record-high prices in 2008 and kept prices on the rise until 2014.

When it comes to precious metals, we have seen an increasing demand for silver and gold. Commodity supercycles have no effect on the industrial use of specialty metals but they become more attractive as an investment tool and a hedge against inflationary pressures.

Why Commodity Supercycles Occur

Commodity supercycles occur in response to profound changes in how societies and economies function. Such changes increase demand for a wide range of commodities. History has witnessed 4 supercycles over the past 120 years. The first such cycle occurred during the US mass industrialization in the 1890s and continued until 1918, driven by an increased demand for weapons and armaments during World War 1. The most recent commodities supercycle occurred in 2001, with China joining the World Trade Organization. China’s large-scale urbanization and economic reforms increased demand for commodities. The fourth supercycle ended with the onset of the global financial crisis in 2008.

New Supercycle on the Horizon

There are some signs that we are witnessing a fifth supercycle driven by the energy transition and global health crisis. Metal and oil prices have skyrocketed recently, and producers find it increasingly difficult to meet demand. In fact, the China – United States trade war and Covid-19 pandemic forced many producers to reduce capacity while there has been little investment in new coal, gas, and oil supply projects.

In addition, the current commodity supercycle is marked by a growth in demand for agricultural products and specialty metals such as silver and gold. Agricultural commodities, in particular, are expected to increase in value due to demand for biofuels and demand from China. As air quality, water, and land are at a premium, demand for agricultural products will remain high in China for the next 5 – 10 years.

The conflict in Ukraine is also pushing up agricultural commodities prices, with over 17 percent increase in the price of corn, barley, oats, and other grains. Vegetable oils have seen the biggest price hikes (23.2 percent) as Ukraine is the biggest sunflower oil exporter while Russia is the world’s second biggest.  Skyrocketing prices for grains, corn, vegetable oils, and wheat are already threatening food shortages around the globe.  Shortages are mainly caused due to disruptions in export flows, with large quantities of produce still sitting in Ukraine because of the blockage of major ports. There is also a risk that some crops would be damaged or destroyed, including spring crops such as soybeans, barley, and corn.

Demand for commodities is expected to increase further as economies around the world are gradually reopening after a significant rise in vaccination rates.

How Is the New Supercycle Different?

When a new supercycle is to occur, we are likely to see some differences. One is the green fiscal stimulus that couples up environmental objectives with crisis spending and efforts to restart the global economy. This transition to a system that is more efficient and cleaner is expected to give rise to new emerging sectors and new jobs and opportunities. The American Jobs Plan, for example, includes a proposed $174 billion investment to accelerate the domestic electric vehicle industry, coupled with commitments to green infrastructure and clean energy. The European Union also agreed a massive green stimulus, with funds to be invested in alternative fuel projects that support climate action. China has announced plans to reduce emissions and achieve carbon neutrality by 2060. In Canada, Covid-19-related spending was the main focus of the previous two budgets but in 2022, the federal government announced a comprehensive package of measures aimed at reducing greenhouse gas emissions. Under the 2030 Emissions Reduction Plan, Canada is taking action to promote clean industrial growth, create sustainable jobs, and achieve zero-net emissions by 2050.

This focus on clean energy means that if a new commodity supercycle is to occur, it will be driven by an increased demand for copper. Copper prices already increased by 17 percent in 2021 amidst sustainable and green initiatives. Copper has a wide range of applications such as high conductivity wires, electrical cables and wiring, and power transmission lines. It is used in green and traditional infrastructure and is a major component in electric vehicles, including charging stations, wiring, inverters, batteries, and electric motors. At the same time, shortages are expected to occur due to pandemic-related disruptions of mining operations in Peru and Chile and an increased demand in China. While demand from China is expected to gradually moderate, it will not do so in many parts of the world.

It is clear that the various green stimulus packages and climate change plans will not drive demand for fossil fuels down, at least not in the short run. After all, if we want to build green infrastructure, we will need traditional fuels. Long-term implications, however, are far from clear.

What Is Responsible Investment

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Responsible investment is an approach or strategy that takes into account governance, social, and environmental factors. Responsible investors acknowledge the fact that assets and businesses underperform when ignoring ethical, corporate governance, or social issues.

Environmental, Social, and Governance Factors

Responsible investment is about opting to invest in businesses that drive change, such as addressing public health issues and growing inequality, mitigating climate change, or improving labor standards. Examples of environmental issues that affect investment decisions are deforestation, pollution, waste, resource depletion, and climate change. Some of the social issues that impact the decision-making process are working conditions, child labor, modern slavery, and human rights. Corporate governance factors that can play a role in the selection of investments are donations and political lobbying, board structure and diversity, executive pay, and corruption and bribery.

ESG Integration

ESG integration is basically the inclusion of governance, social, and environmental factors in investment analysis. Issues such as the human resource policies, R&D, and product strategy of a company are analyzed, based on what issues the asset manager or institutional investor prioritizes. The extent to which the analysis is reliable and thoroughgoing depends on the values, sources of information, experience, and background of the analyst.

What Is Socially Responsible Investing?

Socially responsible investing refers to a diverse set of approaches that utilize environmental and social criteria when evaluating companies. Social criteria can cover a wide range of issues such as respect to gender and race, promotion and hiring practices, occupational safety and health, community welfare, etc. Environmental criteria can be things like:

  • Waste and recycling
  • Impact on natural resources
  • Raw material sourcing
  • Resource and energy efficiency
  • GHG emissions
  • Environmental management

Typically, investors score and select companies based on a set of chosen criteria. They first compile a list of qualifying companies and then evaluate their financial performance.

Thematic investment is a subtype of socially responsible investing whereby funds select companies that fall under a specific theme, such as climate change, pollution control, low carbon energy, or water distribution. A healthcare fund, for example, would invest in high-tech companies, nursing homes, health insurance providers, hospitals, and pharmaceutical companies.

Green investment falls under thematic investing and covers a variety of approaches that seek to support eco-friendly or green assets. These can include waste management, recycling, pollution control, and energy efficiency technologies, smart grids, low carbon vehicles, etc.

Impact Investing

Impact investing is a strategy that seeks to achieve a specific objective while generating financial returns. Such an objective can be supporting companies that hire persons with disabilities, companies promoting access to basic services such as education, healthcare, and housing, or projects providing employment to community members. Basically, the goal is to generate both positive environmental and social impact and financial returns.

Impact investors range from development finance institutions and family and institutional foundations to wealth managers, financial advisors, pension funds, and banks. The impact investment market has attracted a wide variety of institutional and individual players, including:

  • Nonprofits
  • Family offices
  • Insurance companies
  • Private foundations
  • Religious institutions
  • Diversified financial institutions
  • Fund managers

Socially Responsible Mutual Funds

These funds target and invest in companies that meet environmental, religious, moral, and social standards. They choose the securities that make up their investment portfolio based on both financial and ESG criteria such as policies aimed at fostering social inclusion, reducing poverty, or curbing the carbon footprint. Like other funds, they also seek to invest in companies with robust corporate government policies and strong balance sheets. The three main approaches that socially responsible funds utilize are impact investing, ESG integration, and value-based investing.

Typically, they target companies that employ and train disadvantaged minorities, promote responsible forestry, water and clean air conservation, or fight climate change. When looking into different mutual funds, investors typically account for factors such as experience, performance potential, risks, costs, and the extent to which the investment portfolios align with their values. There is a wide selection of socially responsible funds for investors to screen, a few examples being the SDRP S&P 500 Fossil Fuel Reserve, Vanguard FTSE Social Index Fund, and Parnassus Core Equity Investor. Parnassus, for example, excludes companies within the nuclear energy and fossil fuel sectors while the S&P 500 Fossil Fuel Reserve only targets fossil fuel-free companies. Vanguard eschews investments in companies within the gambling, alcohol, and tobacco sectors, civilian firearms manufacturers, and companies within the nuclear power and fossil fuel industries.

Socially Responsible ETFs

Socially responsible ETFs include a range of assets, including sector, international, and domestic equities. ETFs mainly invest in companies based on factors such as environmental and social impact. The iShares GNMA Bond ETF, for example, provides investors with the opportunity to promote affordable housing. The iShares MSCI ACWI Low Carbon Target ETF offers investors the chance to reduce their carbon footprint by investing in companies across a broad range of sectors, including real estate, energy, communication, and industrials, which are less dependent on fossil fuels. There are also ETFs with a focus on gender equity such as the SPDR SSGA Gender Diversity Index ETF, which invests in companies that help promote gender diversity. Another example is the iShares MSCI KLD 400 Social ETF which excludes companies that are involved in adult entertainment, military weapons, gambling, tobacco, and alcohol.

Socially Responsible Investing vs. Responsible Investing

While both terms are used interchangeably, there are some notable differences. Responsible investing refers to a broad range of strategies that consider both environmental and social factors and financial returns. The three main approaches here are impact investing, ESG integration, and socially responsible investing. With SRI, issuers or companies are excluded /negative screening/ or included /positive screening/ as investments based on environmental or social impacts. Positive screening might favor companies engaged in clean technology and alternative energy, environmental sustainability, or social justice. Negative screening, on the other hand, may mean eschewing investments in companies that have unacceptably high carbon footprints or a poor waste management record. Other negative screens may include labor violations, production of defense tools and weapons, gambling, tobacco and alcohol, and lack of diversity on boards. Exclusionary or negative screening is used to exclude companies within industries such as gas and oil and those that are contrary to international conventions and declarations. Common exclusions can also be:

  • Gross human rights violations
  • Nuclear power
  • Companies operating in a particular region or country
  • Hospitals or clinics practicing abortions
  • Companies operating in violation to international agreements such as the Rio Declaration on Environment and Development or the Universal Declaration of Human Rights.

Canadian Guide to Protecting Your Wealth from Inflation

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Inflation is on the rise in Canada and rose to 3.7 percent in July, 2021. This is the biggest jump since May, 2011 and is mainly due to more sectors of the economy reopening and consumers having where to spend their money. While pay rates are set to trail inflation, salary increase budgets are unlikely to catch up with inflationary pressures in 2021. Plus, it is not guaranteed that salaries will go up across all sectors of the economy. Inflation is robust but fortunately, there are ways to protect your wealth and fight the effects of inflation. From buying real estate and investing in stocks to alternative investments and portfolio diversification, there are time-tested strategies to protect your money.

1. Buying Real Estate

Investing in real estate may sound counterintuitive given that the average selling price is $688,000. Prices rose by 38 percent in 2020 alone. In most cases, Canadians looking to buy a home need to apply for a loan. As it turns out, however, the cost of borrowing decreases when wages increase and prices are on the rise. Average home prices are also rising faster than the consumer price index which makes investing in real estate a good hedge against inflation.

Additionally according to the Canadian Real Estate Association, home prices tend to be skewed by listings in expensive metropolitan markets such as Vancouver and Toronto. CREA tracks the house pricing index which gives a more accurate picture in terms of the types and number of properties sold.

2. Investing in Stocks and Bonds

There are investments that actually benefit from inflation, such being energy and retailers stocks. Energy companies profit when inflationary pressures are driven by oil price increases. Retailers also hike prices and considering the pandemic e-commerce boom, investing in e-commerce stocks can be a good idea.

Some equities both benefit and contribute to inflationary pressures, for example, metals, grain, lumber, and crude oil. It makes sense to buy shares in commodity companies either through mutual funds and exchange-traded funds or directly.

Investing in government bonds is yet another way to protect your money from inflation. What portion to dedicate to fixed income depends on how soon you will need cash and your risk tolerance. As a rule, government bonds offer income and security but the shorter the maturity, the lower the yield. That is because investors face less risk of interest rate increases. Bonds with longer maturity are more sensitive to interest rate fluctuations. The choice of shorter maturity depends on factors such as income requirements, nearing retirement, and the need to diversify investments.

3. Alternative Investments

The price of alternative investments such as silver, gold, and cryptocurrencies is also rising in the long run. As they are risky, dedicating a small portion to alternative investments only makes sense. At the same time, they are thought to not only retain their purchasing power but to outperform when inflationary pressures arise.

Also, there is a wide array of investment options to look into, besides bonds and stocks, each with its proposition, value, and risk factor. The range of solutions includes derivative contracts, commodities, antiques and art, managed futures, hedge funds, venture capital, and private equity.

The category of alternative assets is vast, indeed, but there are some factors to consider when building a portfolio. First, investors can choose to own assets such as farmland, commodities, precious metals, and real estate indirectly or directly. They can either buy physical assets or shares like, for example, invest in shares of gold or gold bars. The same is true for other assets such as real estate or farmland. When buying shares, the asset is tied to physical property, thus giving investors a choice between financial and physical assets.

Some alternative investments are classified as risky, such being the case with farmland. The value of farmland has steadily risen on an annual basis over the last three decades. There are no signs of slowing down in the short term, given the demand for commodities and agricultural products. In fact, farms will need to significantly increase production to meet growing demand as global population growth continues.

An alternative solution is to invest in inflation-linked bonds which are pegged to the consumer price index. In this case, the interest and principal rise and are adjusted for inflation. There are many benefits to investing in inflation-linked bonds such as less risk and volatility and higher returns compared to conventional bonds. A word of caution should be mentioned here, however. When deflation occurs, the bond principal will fall below par value, with interest due on the inflation-adjusted principal. Investors are likely to incur capital losses if deflationary pressures persist. The longer the maturity, the more vulnerable bonds become to interest rate fluctuations.

4. Portfolio Diversification

Building a diversified portfolio is an excellent hedge against inflation. The types of assets that can protect an investment portfolio against inflationary pressures include US stocks and REITs, treasuries, TIPS, commodities, emerging stocks, gold, European and Pacific stocks, and international REITs. Real estate investment trusts, for example, buy a diverse range of real estate that is rented out and produces solid returns. There is also an option to invest in international and US REITs and many have done so since the 2008 US market crush. The fact is that REITs invest in both commercial and residential real estate and are more diversified than conventional real estate portfolios. This means that they are more stable and less risky in case of rising inflation and economic shocks.

5. Consider a Fixed-Rate Mortgage Loan

There are currently variable-rate mortgages offered at about or even less than 1 percent. Getting a variable-rate mortgage sounds tempting as it looks like borrowing for nothing but it comes with a hitch. The fact is that a significant increase in mortgage rates could translate in hundreds and even thousands of dollars in interest over the loan term.

In comparison, five-year fixed-rate mortgages are currently available at about two percent. Regardless of inflationary pressures and rate fluctuations, borrowers pay two percent over the course of the mortgage. Locking in a variable-rate loan is a good idea when inflation is rising.

Investing in stocks, alternative assets, and real estate is worth considering given that high inflation could last for years. According to chief economist with Bank of Montreal Douglas Porter, inflation rates could remain at 3 – 5 percent for a year or even two. The outlook for the U.S. is similar, with prices and inflation rising until 2023. In fact, inflation south of the border is higher than in Canada, reaching 5.4 percent in June. Canada, however, is behind the U.S. on the path to economic recovery which is a red flag when it comes to recessionary pressures. Investing in physical and financial assets now can help mitigate the effect of expected rising inflation. With a variety of inflation-proof stocks such as energy and utilities and exchange traded funds, there are plenty of options to hedge against inflation.