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Commodities Ride Record Rally Into 2018

Sumit Roy

What was the hottest asset class at the end of 2017? No one would blame you if you guessed cryptocurrencies or U.S. equities. Both asset classes performed phenomenally throughout 2017, breaking records along the way.

But believe it or not, the group doing the best at the end of the year—and which is still showing signs of strength as the page flips to 2018—is none other than old-school commodities. In fact, commodities are in the midst of their longest streak of gains on record, according to Bloomberg: 13-consecutive days of gains and counting (as of Jan. 2).

 

Bloomberg Spot Commodity Index

 

The end-of-year rally helped commodity ETFs recover from a midyear swoon. At the end of June, all but one broad commodity ETF was in the red for 2017. By the end of the year, the situation had reversed―every broad commodity ETF, with the exception of one, finished the year in the green.

The Elkhorn Fundamental Commodity Strategy ETF (RCOM) was the top-performing ETF of the year in the segent, with a return of 11.1%. On the flip side, the WisdomTree Continuous Commodity Index Fund (GCC) was the sole broad commodity ETF to decline, losing nearly 0.60% in the year.

 

Note: Table measures the total return for 2017 for all broad commodity ETFs for which full-year data is available. 

 

Cheapest Since The '90s?

Heading into 2018, at least a few notable analysts believe that the under-the-radar rally in commodities could continue. Jeffrey Gundlach, the outspoken CEO of DoubleLine Capital, recently said that buying commodities could turn out to be one of the best investments of 2018.

Gundlach believes commodities are as cheap relative to stocks as they were in the 1970s and during the dot-com bubble of the 1990s, periods that were followed by strong outperformance by commodities.

He expects the dollar to weaken, and for commodities—including gold—to rise in 2018.

 

Positive Roll Yields

Meanwhile, Goldman Sachs is also sanguine on the asset class, but for different reasons. The firm recently released a research report in which it recommended that investors overweight commodities, expecting a 7.5% return over the next 12 months.

Goldman cited robust demand and falling inventories as supporting its bullish view.

"Real assets, such as commodities, have historically outperformed as the business cycle matures," Goldman analysts led by Jeffrey Currie wrote in a note published for clients in December. "The diversification case for commodities is also very strong as cross-asset and cross-commodity correlations are now near zero."

Interestingly, Goldman expects nearly all of the returns for commodity investments in 2018 to come from roll yields―the gains picked up from selling near-dated futures contracts and buying later-dated contracts when futures markets are in backwardation.

"We find that it pays to be late and enter commodity markets as the business cycle matures and after backwardation has occurred (in oil it occurred in August of [2017])," Goldman analysts said. "The reason for this is that once the returns are based upon carry and less on price appreciation, the persistence of the carry delivers more stable and dependable returns."

Goldman said that the opposite situation, contango, ate away at much of the returns from price appreciation that commodities saw in 2017. That shouldn't be a problem in 2018, and is the reason the firm expects solid returns for the group even as prices stay largely flat during the year.

More Balanced View

Not everyone believes commodities are off to the races in 2018. Societe Generale has a more balanced outlook for the group, which includes a call for Brent crude oil prices to fall to $56 a barrel by the second quarter. Prices were last trading closer to $67.

"We continue to project a moderate global stockbuild for 2018. As a result, on both Brent and WTI, we are bearish with respect to current front-month prices and current forward curves," analysts at the firm said.

They also expect copper, which is at a multiyear high, to pull back despite supportive supply and demand fundamentals. "The long-term price outlook for copper is undoubtedly very positive," Societe Generale analysts said, but prices "have moved slightly ahead of fundamentals."

The firm projected copper prices would hit $6,600/ton in half a year, notably below the $7,200 level at which copper currently trades.

Corn and gold are other commodities Societe Generale is bearish on. It expects December 2018 corn futures contracts to drop to $3.50/bushel from current levels of $3.86, and for gold to slip to $1,225/oz. from current prices near $1,313.

"U.S. monetary policy is likely to prove a significant headwind for gold, as a rising interest rate environment and still-subdued inflation levels lower the real return on the precious metal," analysts at the firm said.

On the other hand, Societe analysts are particularly bullish on natural gas, lead and tin in 2018.

Sumit Roy can be reached at sroy@etf.com

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