ETFs for investing in the new commodity supercycle

Tom Bailey explains how investors can gain exposure to a predicted boom for commodities. 

Over the past year, the price of many commodities has surged. Copper, a key industrial input, is up around 25% compared to the start of last year, while iron ore is up 75%. Other commodities have also rallied more recently. As index provider S&P Global Platts notes: “From liquid natural gas in Asia to scrap metal in Turkey and Brent crude, commodity prices have surged to new highs.”

Driving this demand, of course, is higher demand and higher expected demand. 

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Like much the rest of the world, China responded to the economic fallout of the pandemic by opening up the government spending taps. In contrast to most developed economies, this focused less on handing out cash to struggling consumers, and more on ramping up infrastructure spending. This has resulted in increased demand for the materials that make these sort of projects possible.

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There is also further expected demand from around the world. More generally, there is an expectation that economies will roar back to life this year, which is a positive for commodity prices. But more specifically, there is also an expectation that the new US administration will now spend vast sums on their own infrastructure projects, particularly focused on green or renewable energy. Being forward-looking, markets will have priced this in.

A new commodities supercycle?

Many argue that all this and other factors are coalescing to create a new “commodities supercycle”. This would be a reversal of the past few years of depressed commodity prices.  

This is the view of Goldman Sachs. In November, the bank released a paper arguing that the “recovery in commodity prices will actually be the beginning of a much longer structural bull market for commodities”.

Goldman Sachs argues that in the 2020s there will be similar drivers for commodity demand as seen in the 2000s. First, they point to the expected boom in government spending in developed economies, particularly green projects. This, they say, can be viewed as the equivalent of the BRICS' (Brazil, Russia, India, China, South Africa) investment boom that fuelled the 2000s commodities market.

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Second, they see a move towards more “redistributive” economic policy in both China and developed economies, boosting consumer demand. This expected uptick in consumer demand should be “comparable to the lending-fuelled consumption increase in the 2000s”.

Not everyone, however, is so bullish. Tony Volpona, a former director at Brazil’s central bank, points out that some view the uptick in commodity prices as unlikely to last. He recently noted in Americas Quarterly: “The opposite view states that our high-tech economy is progressively becoming less commodity-intensive, which will curtail commodities demand even if global growth booms.”

ETFs for commodity exposure

The most popular (and cheapest) ETFs for commodities usually track the famous Bloomberg Commodity Index.

The cheapest ETF on the interactive investor platform tracking this index is the L&G All Commodities ETF GBP (LSE:BCOG), which charges 0.16%. The iShares Diversified Commodity Swap UCITS ETF (LSE:ICOM)also tracks this index for the slightly higher fee of 0.19%, as does the Invesco Bloomberg Commodity ETF (LSE:CMOD).

Over the past six months, these three ETFs have all provided a return of over 8.5%, according to data from FE Analytics (total return in sterling terms). Over the past three months, they have provided a return of around 2.5%.

It is important to note, however, that by tracking the Bloomberg Commodity Index, these ETFs all have relatively high exposure to gold. For instance, the factsheet for the L&G ETF shows that at the end of December 2020, almost 15% of the portfolio was gold. That was the biggest weighting of any single commodity by a wide margin, with natural gas in second place with a weighting of 8.4%.

Gold is unlike most other commodities, with its price not increasing with economic activity. While gold rallied in 2020, over the past six months it has experienced poorer performance, coming down from its summer all-time highs. That will have created a drag on the strong performance of other commodities rallying. 

No perfect commodity ETF

Another option is the Lyxor Commodities Refinitiv/CoreCommodity CRB ETF (LSE:CRBU). The length of its name means that it is truncated to Lyxor Cmdts Rfntv/CrCmd CRB TR ETF on the ii platform.

It tracks the Thomson Reuters/CoreCommodity CRB Total Return Index. The different methodology of this index gives the ETF lower exposure to gold. So, for example, at the end of December 2020 the ETF had 5% in gold. Its biggest weighting was crude oil at 23%, followed by corn at 6.5%.

This has served the ETF well. Over the past six months, it has returned investors 12.4%, a fair few percentage points more than the above-mentioned ETFs. Over the past three months, it has also done notably better, returning around 9%.

Investors, however, might be uncomfortable with the ETF having almost a quarter of its exposure to just one commodity. Its 23% in oil dwarfs all other weightings, which are in the single digits. Another downside is that the ETF is slightly more expensive, charging 0.35%.

There are several other commodity ETF options with different weightings. For example, there is the Invesco Commodity Composite UCITS ETF (LSE:LGCU). This tracks the Solactive Commodity Composite Index. It has a slightly lower weight to both gold and oil, although both are still sizeable at 14% and 11%, respectively. It is also comparatively more expensive, charging 0.4%.

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My view is that the cheaper ETFs tracking the Bloomberg Commodity Index are likely the best option. The ETFs won’t see all of the potential upside of commodity price rises, being restrained partly by the countervailing tendency of gold. But they should still broadly benefit if the bulls are correct about a new commodity supercycle. 

Latin America route?

There is another option – Latin America ETFs. The region is, much to its economic detriment, reliant on the extraction and sale of commodities.

This is reflected in the main indices tracking the region. For example, the MSCI Emerging Markets Latin America index is 21% materials. The index’s largest holding is currently Brazilian miner Vale (NYSE:VALE), which accounts for 10%. The largest weighting is to financials, at 26%. However, it should be kept in mind that the fortune of many of these banks and financial institutions is heavily tied to commodity prices.

Over the past few years, Latin America’s reliance on commodity prices has hurt returns. Over the past five years, the MSCI All-Country World index has returned 111%. In contrast, the MSCI Emerging Markets Latin America index returned just 75% over the same period. Over the past year, the index’s one-year losses stand at 20%, compared to the MSCI All-Country World’s 13.3% gain.

However, over the past few months, performance has started to pick up, largely due to a recovery in commodity prices. On a three-month basis, Latin American equites have returned over 15% compared to roughly 10% for the MSCI All-Country World index.  

The cheapest ETF tracking this index is the Amundi IS MSCI EM Latin America ETF (LSE:ALAG), with an ongoing charge of 0.2%. Other ETFs all cost a fair bit more, with the iShares MSCI EM Latin America UCITS ETF (LSE:DLTM) charging 0.74% and the Lyxor MSCI EM Latin America ETF (LSE:LTMU) charging 0.64%.

There are, however, major risks with this approach. Principally, the biggest country in the index by far is Brazil, which accounts for around 65%. That gives investors a lot of country-specific risk. If for example, Brazilian politics destabilises and global markets sour on the country, that could hurt investor returns regardless of the price of commodities.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.