Advisors and investors that feel they are hearing more and more about commodities and the corresponding exchange traded products in recent months are right. That is a natural result of dollar weakness and yes, the greenback is floundering again in 2018.
After shedding more than 9% in 2017, the Deutsche Bank Long USD Currency Portfolio Index is off 1.79% to start 2018. That index, which measures dollar strength (or weakness) against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc, would need to gain 10.67% to reclaim its 52-week high (as of Feb. 7).
Given commodities’ historically inverse relationship with the dollar, it probably is not surprising that the S&P GSCI Index is up 10.95% for the 12-month period ended Feb. 7. The performance of that widely followed index serves as a reminder of the advantages of using a basket approach to commodities. Sure, exchange traded funds (ETFs) have made it easier for investors to isolate single commodities, such as gold, oil and silver. But for many investors, identifying when an individual commodity will outperform is a tricky endeavor.
The United States Commodity Index Fund (USCI) brings the basket to end users. USCI follows the SummerHaven Dynamic Commodity Index Total Return, a widely followed gauge of of 14 commodity futures. That benchmark’s selection universe consists of 27 commodity futures and, each month, the selections are whittled down to 14.
“The 14 selected contracts are equally weighted and represent six sectors: Energy (WTI crude oil, Brent crude oil, natural gas, heating oil, gasoil, gasoline), Precious Metals (gold, silver, platinum), Industrial Metals (aluminum, copper, lead, nickel, tin, zinc), Grains (corn, soybeans, soybean meal, soybean oil, wheat), Livestock (live cattle, feeder cattle, lean hogs) and Softs (coffee, cocoa, cotton and sugar),” according to the issuer. “The index uses market price signals, including backwardation and 12 month price change, as part of its rules-based selection method. USCI is rebalanced monthly to reflect these changes to the index.”
Why Now For GSCI
While there has been some talk that the relationship between commodities and the dollar is broken, investors should not overlook the fact that USCI has been thriving amid dollar weakness. For example, the greenback slid to its lowest levels in almost four years against major developed market currencies in January while 11 of USCI’s 14 components finished that month higher.
“Between 2003 and mid-2016, the negative correlation between commodity prices and the USD was the rule,” according to BNP Paribas. “Until 2010, the main factor was the imbalance between demand and supply in commodity markets with a causality running from the USD to commodity prices. Namely, because commodity prices are expressed in US dollar, the decline in the USD (against a basket of currencies) has reinforced the impact of stronger demand caused by the acceleration in world growth and the huge fiscal stimulus in China in 2009-2010. And because supply of commodities was lagging, excess demand was prevailing.”
In all corners of financial markets, there will be times when historical norms, such as commodities vs. the dollar, break from the trend. Still, it is important to remember that history is on the side of commodities in weak dollar environments.
COURTESY: S&P DOW JONES INDICES
Here Comes Inflation
Another reason a strategy such as USCI merits consideration right now is rising inflation. While the historical trend for commodities and the dollar is inverse, commodities are, usually, positively correlated with inflation. So as consumer prices rise, commodities often follow suit, explaining why the asset class is a favored inflation hedge.
As the chart below indicates, there were 23 years of low inflation in the 47 years spanning 1970 through 2016 and 24 years of high inflation. Commodities were among the best-performing assets when inflation was trending higher and the worst asset class when consumer prices were subdued.
COURTESY: FINANCIAL PLANNING
While still below the highs seen early in the global financial crisis, data from the International Monetary Fund (IMF) suggest inflation in developed and emerging markets is moving higher.
“Indeed, we expect core inflation of around 2.1% by the end of 2018 – a modest acceleration relative to 2017,” according to PIMCO. “Similarly, we expect the Federal Reserve’s preferred measure of inflation, core personal consumption expenditure (PCE), to accelerate as well, ending the year at around 1.75%, 25 basis points below its target.”
Should those projections come to fruition, that could be a harbinger of more upside for USCI over the course of 2018.
United States Commodity Index Fund® (USCI) (“the Fund”), is not a mutual fund or any other type of Investment Company within the meaning of the Investment Company Act of 1940, as amended, and is not subject to regulation thereunder.
Commodity and futures trading is highly speculative and generally volatile and are not suitable for all investors.
The Fund is speculative and involves a high degree of risk. An investor may lose all or substantially all of an investment in the Fund. Please review the prospectus for the breakeven calculations for the Funds.
Ordinary brokerage commissions apply.
Shares of the Fund are not FDIC insured, may lose value and have no bank guarantee.
Only authorized purchasers may purchase or sell directly with USCI, in minimum blocks of 50,000 shares.
Download a copy of a Fund’s Prospectus by clicking USCI. Please read any Prospectus carefully before investing.
The Fund is not operated in a fashion such that its NAV will reflect the percentage change of the price of any particular futures contract as measured over a time period greater than one day. It is not the intent to operate the Fund in a fashion such that its NAV will equal, in dollar terms, the spot price of any particular futures contract.
K-1s will be available for tax reporting purposes. You may download them electronically through a link on the fund’s website.
ALPS Advisors, Inc. (AAI) has engaged IRIS Werks, LLC (IRIS) to produce analysis and commentary. IRIS currently has a compensated business relationship with AAI. AAI is not affiliated with IRIS.
The content and opinions expressed in this article are that of the author and not the views and opinions of AAI. In addition, AAI assumes no responsibility to ensure the accuracy of the content written by the author.
ALPS Distributor, Inc. is the distributor for the United States Commodity Index Fund. AAI is affiliated with ALPS Distributor, Inc.
The United States Commodity Index Fund administered by Brown Brothers Harriman & Co. and United States Commodity Funds LLC is the General Partner/Sponsor. ALPS Distributor’s, Inc. is unaffiliated with Brown Brothers Harriman & Co. and United States Commodity Funds LLC.
The author is not an investment professional and this article should not be considered investment advice. While the information and statistical data contained herein are based on sources believed to be reliable, the author takes no responsibility to ensure the accuracy of the content. Additionally, this article should not be relied on or be the basis for an investment decision. Information that is historical is not indicative of future results, and subject to change.
S&P GSCI Index: A leading measure of general price movements and inflation in the world economy. The index representing market beta is world-production weighted. It is designed to be investable by including the most liquid commodity futures, and provides diversification with low correlations.
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