It’s an overlay that Pickering notes has outperformed the S&P 500 for the past five months, post the tariff tantrum, and despite positive performance on that index. He notes that a reallocation by institutions towards commodity exposures as well as pickups in certain key commodity segments have helped drive that alpha. The idea, too, is that in a normal equity downturn the commodities exposure would act as a non-correlated hedge to help outperformance. It’s a strategy that Pickering will quickly admit is not without risk.
Pickering notes that there are scenarios that can create short-term correlations between certain commodities and equities. A short-term shock to the global economy, like the announcement of ‘liberation day’ tariffs by the United States, could see both the equity index and the non-correlated commodity hedge fail to perform. On the whole, however, Pickering argues that the diversification offered by long/short commodities can make more sense in this environment than the traditional hedge investors use against equities: bonds.
2022 is arguably the most acute example of accepted wisdom being thrown out the window. Under conditions of high inflation and resulting rate hikes emerging from the COVID-19 pandemic, equities and bonds fell roughly in lock-step. Pickering notes that in periods of normal inflation, the non-correlated relationship between equities and bonds tends to soften. The justification for a 60/40 equity/bond split, he argues, was a sustained multi-decade period of low inflation. That period now appears to be over, and Pickering believes commodities can do what bonds can’t.
The importance of non-correlation may appear particularly timely now, in Pickering’s view, as US equity markets appear more and more concentrated in their exposure to the AI theme. According to data from Polygon, nine of the 11 largest companies on the S&P 500 are directly exposed to AI, either as hyper scalers, software providers, or chip manufacturers. Those nine companies comprise over 38 per cent of the total market capitalization of the S&P 500, meaning an investment into a so-called broad index fund has a significant concentration in a tiny number of mega-cap technology names.
Commodities come with some exposure to that theme, too. Whether that is the use of copper to wire data centres, natural gas to heat them, or uranium for new nuclear plants dedicated to powering the immense computing required in AI. Other commodities, however, have none of that exposure. Cocoa and canola are not tied to AI and when investors are seeking forms of diversification away from this one giant theme, a wide basket of commodities can help.
