Investor Knowledge
September 13 2023

Commodities and the Benefits Of Being Out Of Sync

5 min read

Commodities get a lot of attention from the media. The price of gold, oil and corn are in the national news nearly every day. Commodities are assets that have tangible properties such as energy and energy related resources, precious metals, and agricultural products. They are most often used as inputs in the production of other goods or services and are tied to demand and supply dynamics.

At TD Asset Management Inc. (TDAM), we believe that since commodities have historically moved independently of equity and fixed income markets, they can play an important role in portfolio construction. Commodities have potential to offer inflation protection, portfolio diversification and positive expected returns over time. Against the backdrop of elevated inflation uncertainty, recent challenges in the performance of the traditional 60/40 portfolio and valuation concerns of other asset classes, we have had a strong focus on commodities as an option in this environment.

Why now?

From a commodity cycle perspective, we believe that we are in the early stages of an investment phase which should result in higher commodity returns than exhibited in the last 10-15 years. We further believe we are currently in the later stages of a business cycle. Demand concerns, reflecting worries about a looming recession, have been partially responsible for the weakness exhibited in commodity prices through the first half of 2023. In the coming years, we anticipate returns to outperform our long-term assumption as demand rebounds and supply constraints become more obvious, leading to what we call a "commodity super-cycle"

A commodity super-cycle

A commodities super-cycle can be described as a period where commodity supplies fail to keep up with demand, resulting in tighter inventories, and consistent and sustained price increases – a favourable environment for positive commodity investment returns. There are two ingredients required for a commodity super-cycle: a generational demand shock and an extended period of underinvestment in supply. Today, we believe we have both.

Super-cycles historically have been driven by both robust demand and constrained supply and typically last 8-12 years. The strong returns on global commodities we experienced in 2022 have led many to believe that this may be the beginning of a new commodity super-cycle. At this juncture we feel that after spending the better part of a decade in a bear market, commodity prices are likely in the early stages of a super-cycle.

A unique solution

To take advantage of what we feel will is the beginning of a commodity super cycle, TDAM recently launched the TD Alternative Commodities Pool (The Pool).  The Pool offers more diversified exposure to commodities than single commodity funds such as gold or silver and can be a great complement for balanced portfolios, with an innovative approach that seeks to achieve capital appreciation with low correlation to equity and fixed income markets. The Asset Allocation Team at TDAM is constantly monitoring the impact of global events to help inform our investment decisions - which is unique in the marketplace compared to the broadly used passive, systematic, or indexing approaches used by other funds with similar objectives.

An improvement of risk adjusted returns

In summary, we see the allocation to commodities improving portfolio risk adjusted returns through time, especially in environments where inflation is elevated. Commodities can provide inflation protection, afford low correlation and positive expected returns over time. Moreover, we believe that we are likely entering an environment where commodity returns exceed our long- term assumptions and anticipate inflation to be more volatile than in recent history, which would make the benefit of adding commodities even more pronounced.


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