Commodities Move Higher

John Leiper – Chief Investment Officer – 10th July 2020

The 10 year US Treasury yield has remained remarkably steady over the last few months, particularly as inflation expectations have gradually risen.

This divergence may indicate yield curve control from the Fed, which is policy designed to keep Treasury yields at a particular level to stimulate the economy.  

Real interest rates, which account for inflation, are calculated by subtracting inflation expectations (in pink) from nominal yields (in white).

As shown in the chart below, the 10 year US real yield recently fell to a new 7 year low.

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We believe ongoing monetary and fiscal stimulus will continue to suppress real yields.

Whilst nominal yields have less room to fall (unless we see negative interest rates) the key driver will be rising inflation expectations (please read our inflation blog here).

As shown in the chart below, inflation expectations are picking up even as real world inflation remains subdued.

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This outlook is bullish real assets and we have implemented this strategy across the portfolios via a commodity carve-out (read more here) comprised of precious metals, including gold and silver.

There is a strong inverse relationship between real yields and gold. As shown in the chart below, the decline in real yields (the right-hand axis is inverted) has just this week driven gold back above $1,800 an ounce.

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Meanwhile, silver is in the process of breaking through upside resistance.  

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Whilst precious metals have already performed well this year, expectations for the next 12 months forecast the strongest outperformance, relative to the S&P 500, since the subprime mortgage crisis.  

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In the chart below I have highlighted in yellow each occasion the above ratio falls below the zero line (indicating forecast precious metal outperformance). As shown, each period is consistent with precious metals outperforming the S&P 500 equity index over time. Market expectations tend to be self-fulfilling and this strong track record points to further potential gains.

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We also like Copper and recently added an allocation to the red metal across the commodity carve-out. The coronavirus is now peaking across major copper producing countries such as Chile, Mexico and Peru meaning supply is falling faster than demand, buoying prices in the process. In the derivatives market, the recent move into backwardation (where spot prices are greater than forward prices) also points to relative outperformance versus equities.

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This uptick in commodity prices is consistent with the recent performance of mining stocks. Rio Tinto is one such example. This company is involved in mining a wide range of commodities including gold, silver, copper and many more and the recent pick-up relative to generic inflation expectations points to commodity specific price inflation.

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We think commodities can continue to perform well in the current environment and have positioned the portfolios accordingly.

This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.  

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