Commodities Were Experiencing Tailwinds Before the Russia-Ukraine War

In 2021, commodities outperformed bonds and equities for the first time in almost a decade. Very low inventories, improving demand, and a muted supply response to higher prices contributed to a sustained upswing across a broad range of commodities.

As FIGURE 1 demonstrates, commodities had already experienced a sustained run-up in value before Russia invaded Ukraine. The war amplified this trend and led to a sudden and sharp price increase in a wide range of commodities that Russia and Ukraine supply to the world. However, some markets are now selling off; Russia's risk premia are lower for now. Barrels of West Texas crude oil dropped in price in March, but are still up significantly from the lows of April 2020.

A combination of official sanctions and self-sanctioning buyer behavior may at least reduce Russian availability across oil, natural gas, some industrial metals, and agriculture (Russia and Ukraine combined supply ~30% of the world’s wheat). Consequently, where inventories were low beforehand, they may become even tighter.

Figure 1

Commodities Have Been Performing Well, Even Before the Outbreak of War

Bloomberg Commodity Index

Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. See below for index definitions. Source: Bloomberg.

The Secular Bull Case for Commodities

With inflation reaching 40-year highs and demand for most commodities increasing, we think the commodities asset class exhibits a great opportunity. Our reasons for believing in the long-term bull case for commodities are as follows:

Commodities appear cheap on an absolute and relative basis
Commodities are historically one of the best inflation hedges
Greenflation

Commodities Appear Cheap Now

As FIGURE 2 indicates, commodities appear to remain cheap from a historical perspective, despite their recent rise in value. Similar to conditions prevailing in the early 2000s, commodities are currently experiencing underinvestment in production capacity while also preparing for a possible capital-expenditure boom. However, the early 2000s is now widely considered to be the era of peak US political consensus. Today, we’re headed in a more fraught political direction.

FIGURE 2

Commodities Are Cheaper Than Equities Now
Bloomberg Commodity Index vs. S&P 500 Index, shown as a ratio

Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. Data as of 12/31/21. Returns may increase or decrease as a result of currency fluctuations. Forecasts may not be realized. Sources: Schroders, Bloomberg.

Commodities Have Outperformed in High Inflationary Environments

Commodities may provide an effective strategy against rising inflation that few other asset classes have been able to offer historically. As FIGURE 3 suggests, low-and-rising and high-and-rising inflation have always been the sweet spot for commodities; during those particular periods, commodities have yielded a positive return over the inflation rate 69% and 84% of the time, respectively.

FIGURE 3

Examples of Asset-Class Returns Exceeding the US Inflation Rate
Rolling 12-Month Periods Between 1973 and 2022, % by Inflation Rate

Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. Percentages may not add up to 100% due to rounding. Data from March 1973 to February 2022. Based on rolling 12-month returns relative to the contemporaneous rate of inflation, where frequency is less than 50% (red), less than 67% (amber), or greater than 67% (green). Rising/falling is defined as the change in the inflation rate over 12 months. Low/high inflation is defined as the average inflation rate over the preceding 12-month period. Indices used to define the above-listed asset classes are as follows: US Treasuries – ICE BAML 7-10 Year US Treasury Index; US Equities – MSCI USA Index; T-Bills – Datastream US 3-month Treasury Bill Index; REITs – FTSE Nareit All Equity US REITs Index; TIPS – Bloomberg US TIPS Index; Commodities – S&P GSCI Commodity Total Return Index; Gold – Datastream Gold Bullion LBM $/t oz; Inflation – Consumer Price Index. Sources: Datastream Refinitiv and Schroders.

Greenflation

We believe a new commodity supercycle, driven by climate-change policy and fiscal dominance, is underway. Unlike past commodity booms, the world today is focused on climate change. Environmental, social, and governance (ESG) considerations are suppressing supply responses and muffling price signals for some commodities. As the world seeks to lower emissions, greater and greater metals investments are required (FIGURE 4).

Assuming a 2% growth in copper demand on a compounded annualized rate, and with current forecasted supply growth, we believe deficits could breach 1 million tons by 2027. By 2030, total energy-transition demand for copper could reach 30% of total demand, up from less than 15% in 2020. To be clear, the scale of the supply gap doesn't mean the world is running out of copper. It means at current copper prices, and assuming 2% demand growth, there is insufficient supply. This is just one example of a scenario that may unfold across a range of input materials relating to the energy transition. This gives us reason to believe we'll see many metals prices move higher and higher.

FIGURE 4

Energy Transition: Accelerating Demand for Metals
Metals needed to support a 2-degree temperature-limit trajectory* would require a ~$1 trillion of investment over the next 15 years.

Metals depicted above: Cu–copper; Ai–aluminum; Ni–nickel; Co–cobalt; Li–lithium. Mt=metric tons. Mt/a=metric tons accelerated. * Climate scientists have set a goal of limiting the planet’s near-term warming to an increase of less than 2 degrees Celsius. ** AET2 demand=accelerated energy transition demand. *** ET demand=energy transition demand. Sources: Bloomberg Intelligence, BNEF, Schroders.

The overall impact of critical climate-change mitigation policies on current investment in energy, metals, and agriculture is the underappreciated driver of greenflation dynamics. Clearly, the energy transition is set to see demand for metals rise sharply in the coming years as the world commences the switch to electric vehicles and more renewable energy sources. However, many other commodities are also positioned to experience a rapid uptick in demand in the coming years, especially in agriculture, where major supply challenges lie ahead as a result of water and fertilizer shortages.

Experience in Commodities

The Hartford Schroders Commodity Strategy ETF may be appropriate for investors seeking actively managed exposure to the commodities asset class and value management by an experienced team of dedicated commodities specialists.

The Fund adheres to the following investment approach:

Fundamentally driven, actively managed with commodity preferences driven by four pillars of analysis: fundamental, quantitative, technical, and sentiment research of individual commodities. All commodities are analyzed for ESG factors during both the fundamental and quantitative stages of the process.
Commodity analysis forms the core of the Hartford Schroders Commodity Strategy ETF's process. Our experienced investment team develops 3- to 12-month price forecasts for commodity markets and maintains a scorecard for all commodities within the opportunity set, thus enabling the team to rank opportunities based on the output from its investment process. Using liquidity-based diversification rules, the team establishes active positions relative to the benchmark.
Implementation is largely focused on commodity futures traded on exchanges.

Final Thoughts

There was a long-term bull case for commodities even before Russia invaded Ukraine. We believe commodities remain an attractive asset class and that those long-term drivers are still in place.

Hartford Schroders Commodity Strategy ETF: HCOM

To learn more about the Hartford Schroders Commodity Strategy ETF, talk to your Hartford Funds representative and visit hartfordfunds.com

Index Definitions

Bloomberg Commodity Index comprise families of investable benchmarksand systematic strategies designed to provide exposure to a broad universe ofphysical commodities, with no single commodity or category dominating the index.

Bloomberg US Treasury Inflation-Linked Bond Index measures the performance of the US Treasury Inflation Protected Securities (TIPS) market.

Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Datastream US 3-month Treasury Bill Index is a simple total total-return index of 3-month US Treasury Bills published by the Federal Reserve.

FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of US equity REITs. Constituents of the index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.

ICE BofAML 7-10 Year US Treasury Index is a market-value-weighted subset of the ICE US Treasury Index series designed to broadly represent the performance of US dollar-denominated, fixed and floating-rate US Treasuries.

London Bullion Market Association (LBMA) is a professional organization that oversees the wholesale gold and silver markets in London, England, center of the world’s physical bullion trading. $/t oz=dollar per troy ounce. A troy ounce is a unit of imperial measure and contains 31.1035 grams of 24 karat pure gold.

MSCI ACWI ex USA Index is a broad-based, unmanaged, marketcapitalization weighted, total-return index that measures the performance ofboth developed and emerging stock markets, excluding the US. MSCI indexperformance is shown net of dividend withholding tax.MSCI USA Index is a free float-adjusted market capitalization

MSCI USA Index is a free float-adjusted market capitalization index designed to measure the performance of the large and mid cap segments of the US market. With 629 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.

S&P 500 Index is a market capitalization-weighted price index composed of500 widely held common stocks.

S&P GSCI Commodity Total Return Index is a broad-based set of commodity-index benchmarks designed to be investable by including the most liquid commodity futures and by providing diversification with low correlations to other assets.