Commodities Have Miles to Run on Rate Hike

Written by: Roland Morris , Portfolio Manager and Strategist

The March 21 announcement by new Fed Chairman Jerome Powell indicated that the Federal Reserve is likely to be more aggressive in its rate hiking policy over the next few years as the effects of reduced business regulation, broad fiscal spending, and stimulative tax cuts are fully incorporated into the economy. After nearly a decade of the effective Federal Funds Rate hovering around 0%, we feel the time for investors to critically evaluate their portfolio's performance in rising interest rate environments has arrived.

Looking at tables of historical performance for a number of asset classes in rate hiking cycles over the last 50 years, perhaps most striking is the performance of commodities—including gold .

Commodities and interest rates both tend to rise late in the economic/business cycle. As a normal cycle develops, the economy expands and gains momentum. Demand for commodities also begins to outpace production and existing supply. The Fed generally responds to this economic momentum by raising rates as inflationary expectations begin to rise. The objective is to extend the economic cycle by keeping interest rates at a level that allows the economy to operate at full employment while maintaining its predetermined inflation target (2% in the current cycle). This is why when you look back at prior expansionary economic cycles, commodities tend to rise as the central bank raises rates.

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Economic/business cycles are never exactly the same, and the current cycle is no exception. But we are most likely entering the late stages of this expansion. Once again interest rates are rising along with commodity prices. This economic upturn has been the slowest post-war expansion we have experienced and is soon to become the longest. Consequently, the global economic expansion has taken longer than expected but is gaining momentum. Demand is starting to outpace production and available supply in several important sectors.

There are expected, and possibly more aggressive, interest rate hikes over the next several years, and potential commodity supply constraints resulting from years of capital expenditure reductions in the metals and oil industries. Between these, we believe investors have more than enough reasons to reconsider their allocations to this space.

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