How HNW investors view commodities in inflationary times

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With prices and the cost of borrowing going up while many investment sectors are experiencing market turmoil, high-net-worth investors and their family offices may find themselves considering commodities.

The logic is obvious. Inflation in Canada was up 7.7 per cent annually in May, the highest since 1983, according to the data website Trading Economics.

The cost is going up fast for all kinds of goods, ranging from oil and natural gas to coffee, grain and soybeans, and microchips. People and businesses need all these things constantly, so it would make sense that investing in them directly can be especially profitable right now.

“I have been worried about [the current] medium-term inflation for some time,” says Keith McLean, executive vice-president of Calgary-based Viewpoint Investment Partners, which oversees about $450 million of assets and is part of the Viewpoint Group, a private family-owned organization created to support the Van Wielingen family.

“Many investors in Canada have been ill-prepared for the recent inflationary pressures. With these worries about medium-term inflationary pressures, a higher allocation to commodities should be prudent for the next two-to-three years at least,” he says.

Investors differ on whether or not to jump into commodities

Not every high- and ultra-high-net-worth investor is hightailing into commodities.

“We’re just not seeing it. Our members’ holdings in commodities are negligible,” says Leon Goren, chair of Toronto TIGER 21, part of a global peer membership network of high-net-worth investors, entrepreneurs and executives.

Investors who are not moving strongly into commodities are taking a longer-term view of what is likely to happen to the prices of these goods, Goren explains.

“For example, the price of oil and gas is jumping right now because of the war in Ukraine, but in the coming years, everyone in the world is looking to move away from fossil fuels. Our members tend to look at the longer horizon,” he says.

Elsewhere, though, the trend to commodities is unmistakeable.

“Investors are pumping more money into commodity funds than at any time in the last decade,” Bloomberg reported in February. By that month, broad-based commodity exchange-traded funds held more than US$21 billion, the most since at least 2007, according to Bloomberg’s data.

Inflationary environment shares similarities to 1970s

McLean sees similarities between today’s economy and the period from 1968 to 1975.

In the first five years of that era, the “Nifty Fifty” basket of blue-chip stocks on the New York Stock Exchange soared and borrowing costs were still relatively low. Then the Mideast Yom Kippur War broke out in October 1973, resulting in an oil embargo, rising commodity prices inflation that grew worse by 1975 and lasted into the 1980s.

There are similarities to today, McLean says: “Technology and ‘meme’ stocks [stocks that are fads or have a cult following among retail investors] are leading a valuation surge, the COVID response has led to easy financial conditions and Russia’s attack on the Ukraine may be the catalyst for another inflationary crisis.”

The move into commodities may not be as strong or last as long this time as it did in the inflation-plagued late 1970s, but “a medium-term inflationary episode could lead to strong performance in commodities,” McLean adds.

Lest there be doubt that inflation will linger into the medium term, U.S. Treasury Secretary Janet Yellen said on June 7 that, “I do expect inflation to remain high,” while the U.S. Congressional Budget Office’s economic outlook predicted that rising prices will continue into next year.

On June 9, Bank of Canada Governor Tiff Macklem also said that the central bank may move aggressively to fight inflation by raising interest rates to 3 per cent or more from the current 1.5 per cent benchmark.

Commodities can provide diversity to a portfolio, whether high-net-worth or otherwise, but their behaviour as an inflation hedge can also be hard to predict, McLean says.

“Short, sharp and transitory episodes [of inflation] can lead clients to add inflation hedges at the wrong time. There will be a point when investors should begin to lower exposure back to a core position,” he explains.

The risk in investing in commodities can sometimes be out of sync with the reward. In an article in December on Morningstar.com, writer Bryan Amour pointed out that commodities outperformed equities when the stock market crashed in 1987, but failed to do so in the crash of 2008.

There is also the challenge of exactly how to invest in commodities. The current price, or spot price, is not that relevant. “You would not be able to buy a bushel of corn and store it in your garage in the hopes of a big rally in corn prices next year because the corn would spoil, get eaten by vermin, and so on,” Amour points out.

Buying commodities through futures contracts

The typical way to buy into commodities is through a futures contract, where the buyer and seller lock in the price at a future date. Typically, these contracts are sold and rebought into the future over and over – a process called rolling – which, among other advantages, means that the buyer will not get stuck with a truckload of soybeans or a tanker full of oil.

While investors can buy and sell contracts for individual commodities, there are more efficient ways to add these to a portfolio. For example, McLean’s firm offers its Viewpoint Commodities Fund, which trades in a broad range of commodities rather than piling into one area that is riding high temporarily.

“Diversification is critical in this asset class, as many individual commodities provide only moderate returns over time, with significant volatility,” the firm explains.

Investing in a basket of commodities through a fund can have advantages over buying into an individual sector or a commodity-based company, argues Viewpoint’s chief operating officer Scott Smith. “Equities do not perform well in inflationary environments,” he says.

Individual companies may not be able to pass on their own price increases to consumers in a tight economy, and they may have trouble with cash flow and borrowing because of higher interest rates, Smith explains.

It’s better to use a fund to “own the commodity, not the company,” he says.

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