Inflation is quickly becoming top of mind for many as everything from ice cream to cars gets more expensive. Investors are beginning to recognize that we’re experiencing the highest inflation levels in 40 years. In our view, we may be entering a market that could be quite favorable for inflation-hedging assets broadly and commodities, in particular. Critically, this environment is coming on the heels of a decade or more of institutions deallocating from inflation-sensitive areas.
Inflation hedging in 2022 and beyond
Commodities markets were up roughly 27% in 2021, nearly mirroring the performance of the S&P 500 Index (up 28%). But a key differentiator is what may be ahead at this point in the economic cycle. The US Federal Reserve has signaled it is likely to begin raising rates and historically, this environment has favored inflation-hedging assets like commodities relative to equities and fixed income.
Furthermore, commodities price inflation is fueling a virtuous cycle of opportunities, bolstering the asset class’s case as an inflation hedge. For example, energy tightness is driving up energy prices, which are a key input into metals production, which itself becomes a higher-cost input into energy production.
Importantly, we believe several supply and demand factors are also driving a structural and cyclical opportunity in commodities markets.
Attractive supply and demand dynamics
Commodities inventories today — from energy to agriculture to metals — are at or near their lowest points since at least 1990 (Figure 1). Falling inventories signal that supply is running far behind demand — and that is despite demand not yet fully recovering from pre-COVID levels.