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Although 2020 was less than a banner year for the commodities sector, the future looks bright. 

“The coronavirus pandemic has left the commodities industry reeling, disrupting supply chains and slashing demand,” according to S&P Global Platts president Martin Fraenkel.

In April 2020, for example the Bloomberg Commodity Index BCOM (which tracks 23 commodity futures markets) traded at an all-time low, according to Dow Jones Market Data. But it managed to rally more than 27% from that low. 

Fundamental economic changes in the energy sector and a weaker dollar are anticipated to boost commodities in the year to come. But, the rally isn’t expected to impact all commodities equally. 

Here’s what investors should know about commodities in 2021. 

What Are Commodities?

Commodities are “raw materials or agricultural products that can be bought and sold.” They generally fall into one of three categories: food, energy, and metals. They include wheat, corn, soybeans, coffee, or other foodstuffs; cattle or other stock animals; cotton; lumber; precious metals such as gold, silver, or copper; domestic and foreign currencies; and coal, oil, and other fossil fuels. 

Commodities are traded on a futures market. There, potential purchasers of commodities can participate in the auction market for the payment of goods which will be delivered on a specified future date.

Because investing in commodities can be complicated for an individual, commodity funds can be a more accessible and attractive alternative. As the name suggests, commodity funds invest in baskets of commodities. Commodity funds are typically themed such that an energy resources fund might invest in oil and natural gas or an agricultural goods fund might invest in a variety of agriculture goods. Commodity funds are generally not diversified across commodity types. 

The three main types of commodity funds, according to BlackRock, include: (1) Index funds, which track an index that includes various commodity assets; (2) Commodity funds, which invest directly in the underlying commodity asset; and (3) Futures-based commodity funds, which invest in commodities through futures contracts.

Investors can also invest in commodities through mutual funds, which typically invest in companies that deal with commodities. 

Why Invest in Commodities?

Commodities are a means of diversifying portfolios in order to protect against loss. The prices of commodities are impacted by supply and demand, exchange rates, inflation, and the general economic outlook. Because of these factors that can cause price fluctuations, commodities can be riskier than stocks and bonds. By the same token, they also have the potential to deliver above average profits.

According to S&P Global Platts, the five commodity themes to watch in 2021 include: (1) energy transition, (2) carbon reduction via carbon pricing, (3) a supercycle 2.0, (4) disruptive technology, and (5) post-pandemic unilateralism. 

Energy “The coronavirus pandemic has accelerated change in the global energy system, from historic declines in GHG emissions, inflections in demand trends and shifting production patterns, to an increased energy transition focus and aspirations towards net-zero emissions,” according to S&P Global Platts’ global director of analytics, Chris Midgley. Investors around the globe are paying attention. “The world’s largest oil traders are rushing to plough billions of dollars into renewable energy projects in the next five years, as they speed up preparations for a dramatic shift in the world’s energy mix,” according to the Financial Times. As the world’s energy sources shift, so will investment dollars. 

Reducing and Valuing Carbon—According to the Commodity Futures Trading Commission, “climate change poses a major risk to the stability of the U.S. financial system and to its ability to sustain the American economy.” Even more, according to the report, “financial markets will only be able to channel resources efficiently to activities that reduce greenhouse gas emissions if an economy-wide price on carbon is in place at a level that reflects the true social cost of those emissions.” Pricing carbon makes polluting expensive, rather than free, in order to discourage polluting. Currently eleven states have active carbon-pricing programs. Pricing carbon federally is the job of Congress rather than regulators, per the report. Although there have been numerous attempts to authorize a federal carbon tax in recent years, none have succeeded. A greater push for clean energy, however, could change this. 

Commodities Supercycle 2.0 A supercycle can be defined as “decades-long, above-trend movements in a wide range of base material prices deriving from a structural change in demand.” As the world comes out of the COVID-19 crisis, it is expected to do so with “an emphasis on a green industrial revolution and a policy focus on social need” driving fundamental economic change. The push for decarbonization, specifically, is linked to an anticipated rally in commodities, from zinc, nickel, copper to iron ore and beyond— in other words, a commodity supercycle. 

Innovative disruption— As the world’s energy structures shift, new technologies—  from 5G to AI to blockchain— that solve problems, improve efficiency, reduce costs, and act as changemakers in the market will emerge. These will lead to significant commodity investment opportunities. 

Unilateralism— Ensuring food security throughout the pandemic has led countries including China to invest in more infrastructure to increase agricultural production. “The return of China as a major force in the global corn and soybean markets may add a further bullish factor to sentiment, as the restocking of the hog population affected by the 2018 swine flu outbreak could increase the country’s corn import quota threefold from 2020’s 7 million mt,” according to S&P Global Platts. As a result of the disruptions caused by the pandemic, countries will become more aware of how they operate both as part of the global supply chain and outside of it.

The world will eventually emerge from the COVID-19 crisis that rocked 2020. And, like any global crisis, it will leave the world forever changed. New solutions and new demands accelerated by the pandemic will drive markets to grow in new ways, adding new dynamics to what was pre-pandemic “business as usual.” The future of the commodities market will no doubt reflect changes across the industries that emerge with innovation and resolve.  

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The information and data are as of the February 1, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi. 

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