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Do Commodities Do Well in a Recession?

As market volatility continues in the shadow of COVID-19, and with the other global shockwaves markets have experienced the last few years, investors are eager to make sense of the chaos—in a way that will boost their portfolio returns, of course.

In times of volatility, Wall Street’s attention inevitably turns to commodities, like the eye of Sauron searching for hobbits. Commodities are looked to for everything from being predictors of a recession to investment opportunities that help hedge against volatility. Commodities in a downturn, like hobbits, hold many secrets. 

But as we dig into what commodities do during recessions, their secrets will be laid bare, and you’ll be able to decide whether you should add real assets to your portfolio in bear markets.

The case for commodity investing 

Why do investors turn to commodity investments? Here’s why you might want to consider them.

Hedge against inflation

Commodities are often considered a way to hedge your portfolio against periods of high inflation

Why? Simply put, the stock market tends to perform worse during high inflation and rising interest rates. Consumer spending goes down, corporate profits become unpredictable, and investors have to sift through a lot of information for it all to make sense.

On the flip side, some commodities can do quite well during inflationary periods. Consider how the prices of food, oil, natural gas, and other raw materials have increased over the past year. Counterintuitively, investors in these commodities are benefiting from inflation and reducing the pain in their overall portfolio. With the right timing and asset mix, investors can realize gains even if stocks have dipped and inflation is surging. Despite recent fluctuations (some would call them corrections), commodity markets are up by over 40% compared to pre-pandemic levels.

Diversification

The rule of thumb that every investor should diversify has become cliché for a reason: diversification works. Commodities and commodity funds represent an easy and fruitful way for investors to diversify. 

ETFs and mutual funds can hold diversified baskets of commodities and futures contracts, meaning investors can gain exposure to real assets with tolerable levels of risk. With such a wide array of options available, commodities become an excellent diversification mechanism to hedge against losses elsewhere in the portfolio while holding the potential for solid returns across business cycles.

Safe haven

A safe haven asset is expected to hold or even gain value during economic downturns and periods of uncertain monetary policy. In a bear market, even a prolonged one, some commodities can act as safe havens.

This relationship is why investors tend to increase their investments in gold when the threat of economic uncertainty looms. Gold has held its value reasonably well during recessions and shocks like the 2019 COVID crash.  

Other commodities that may act as safe havens include silver, copper, livestock, sugar, soybeans, and corn.

Those are some most common reasons someone may add commodities to their portfolio, but how do commodities actually perform during a recession?

Commodities are tied to economic output

Commodities are the building blocks of the physical world, which sets them apart from traditional securities like stocks and bonds. When you own commodities, you own part of something real. 

Commodity supply and demand, the fundamental drivers of price, are determined by current economic activity and forecasted growth. If consumers are spending on travel, that will be reflected in gas prices. If demand is up for new cars, metals used in chip-making might see a bump.

Of course, commodities are prone to macroeconomic shocks and surprises that economists may not always be able to predict. Shortages and supply chain disruptions related to the Russia-Ukraine war drove up the price of nickel, for example.

Commodity performance recessions

In 2020, the COVID-19 pandemic caused what can only be described as a collapse across most commodities.

Commodity ETF DBC backtested performance through the COVID crash in 2020.

Commodity ETF, DBC, underperformed SPY from January 1st, 2020 through December 31st, 2020.

But this was followed by an equally sharp rebound in prices, and today most commodities are above pre-pandemic levels. 

Commodity ETF DBC backtested performance from January 2020 through September 2022

Commodity ETF DBC backtested performance from January 2020 through September of 2022.

While this might seem unique to the global effect of a pandemic, cycles of booms and dips in commodity prices have been common in recent decades.

In 2008, oil prices defied logic as they rose 60% while the rest of the economy shrank. Eventually, crude oil prices crashed and caught up with the rest of the global financial crisis.

Oil ETF DBO backtested from inception through December 31st, 2010.

Oil ETF, DBO, backtested from inception January 5th 2007 through December 31st, 2010.

Commodities can perform well during stagflation.

You’ve been hearing about it for some time now: Will the U.S. head toward a period of stagflation? This portmanteau of the words “inflation” and “stagnation” refers to a period where inflation remains high, but economic growth stalls and comes to a standstill. It’s also called recession inflation.

When it comes to commodities, we don’t have to do much guessing—we can look to the stagflation of the 1970s for guidance. This was the last time we had an inflation problem on the same scale compared to where we are in 2022.

Looking at the commodities cycle of the recession/stagflation period of the ‘70s, it’s clear the boom and bust cycle continued, with commodity prices ultimately enduring and providing substantial returns for those that held on through corrections.

In 1973, for example, oil prices were up 130%. A correction of 23% then spooked some investors before commodities ultimately outperformed equities and bonds.

Data tells us repeatedly that commodities follow cycles during a recession, and the things that make commodities a worthwhile investment during stable times make them attractive during a recession.

Are commodities right for your portfolio?

Commodities are often talked about as if every investor should be actively involved, but there are nuances with this asset class. 

First, determine your risk tolerance. Commodities are volatile and prone to periods of low or negative returns, called commodity supercycles. Investing in commodities requires some level of knowledge and risk-taking and may not be right for every investor.

You should consider what type of portfolio you want to build and how important it is to have liquidity. While some commodities are close to liquid, many are considered illiquid—if you own a timber farm, for example, someone will need to buy it before you can realize your returns.

Learn more about whether commodities are right for you.

Commodities in a Recession

What happens to commodities in a recession? Based on what we’ve seen, they will follow a boom and bust cycle but ultimately trend upward as the economy grows and demand increases in the long term. And even in cases of stagflation or inflation-recessions, they are likely to outperform stocks and bonds.

But managing commodities typically requires a great deal of attention. Strategies like trend following and momentum need technical savvy and a strong sense of timing to buy and sell at the right time. Investors have their pick of how to invest in commodities, from futures to ETFs, only adding to the complex decision-making involved with trading commodities. Composer can help investors manage and automate commodity trading strategies. Sign up for a trial today to try simplified algorithmic investing for free.

Investors will need to consult with their financial advisor and consider their long-term goals and how much risk they’re willing to take. For the right investor, commodities might become an attractive investment in a down market.

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