All eyes on inflation lately. US headline inflation, as measured by the Consumer Price Index (CPI), hit an eye-popping 9.1% year over year for June 2022, its highest level since 1981. The following month, it fell to 8.5% year over year, aided by some near-term energy price relief and improved supply-chain conditions, and may well have peaked for 2022 — a welcome respite for consumers and businesses feeling the pinch of today’s elevated prices. The US Federal Reserve’s (Fed’s) commitment to raising interest rates has pushed inflation expectations down as well (Figure 1), leading to a pause in the recent outperformance of inflation-sensitive assets.

However, we are not out of the woods by any means. Core US inflation (ex-food and energy prices) remains uncomfortably high at around 6%, with a broad number of contributors across the underlying subcategories. Better-than-expected jobs growth and historically low unemployment have also driven labor costs up sharply. More to the point, we think the structural inflation story 2022 began with is far from over. With that in mind, we believe now may be an opportune time for investors to add real-asset and inflation-sensitive exposures to their portfolios.

What has this meant for real assets?

With inflation expectations down and a global recession now baked into many economic forecasts, natural-resource equities and commodities struggled in June and the first half of July, before rebounding over the last month. We believe the structural supply challenges for these sectors are still in place and will remain important return drivers going forward:

• Energy: A lower demand outlook, Russia’s ability to continue exporting, and US strategic petroleum reserve releases have put downward pressure on oil prices since early June. But supply challenges may persist, as materials/labor inflation moves marginal costs higher and recession fears further deter volume growth. In the meantime, elevated prices have allowed energy companies to continue returning capital to shareholders.
• Industrial metals: China’s slow rollback of its COVID lockdowns and ongoing issues in the country’s real estate sector have weakened demand for industrial metals. But increased spending on global infrastructure and renewable energy could help offset some of this going forward, while investment in new metals production remains scarce.
• Precious metals: Higher real interest rates and a stronger US dollar have been headwinds for gold prices, in spite of today’s lower-growth/higher-inflation macro environment. However, if global growth remains low and central banks reverse course on their rate-hiking cycles, gold and other precious metals could once again serve as a hedge against stagflation.
• Agriculture: Ukraine’s ability to export wheat and favorable growing weather so far this year have conspired to push grain prices largely back to where they started the year. Yet global grain inventories remain quite low, with volatile weather patterns making future crop yields more difficult to predict.
• Equities vs commodities: While natural-resource equities were down materially in the second quarter, the commodities themselves held up considerably better. First, while the equities are pricing in lower demand, the commodities are priced based on shorter-term supply/demand dynamics, which remain tight. ¹Second, commodities’ “carry” (roll yield) has stayed positive, meaning price appreciation is not needed to earn positive total returns in this asset class.

¹Roll yield is the amount of return generated in a commodities futures market after an investor “rolls” a short-term contract into a longer-term one and profits from the convergence of the futures price toward a higher price.

Related content

• Mid-2022 Inflation Outlook
• Commodities in 2022: Opportunities amid inflation