Commodities for rising interest rates

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Zach82
Posts: 10
Joined: Thu Sep 17, 2015 1:52 pm

Commodities for rising interest rates

Post by Zach82 » Mon Jan 22, 2018 10:33 am

I am wondering if the better informed here have opinions on what commodities may do in a rising interest rate environment?

Thanks,
Zach

Beehave
Posts: 288
Joined: Mon Jun 19, 2017 12:46 pm

Re: Commodities for rising interest rates

Post by Beehave » Mon Jan 22, 2018 1:28 pm

I'm no expert, but I have an opinion... :?

There are many ways to obtain and hold commodities -- buy ETF precious metal equivalents, buy mining stocks, buy the metals, invest with hedgers.

Each has costs and risks and high volatility. You can parse them this way and that, but my opinion is that when push comes to shove, if you are buying for inflation protection, if you simply invest a small amount you are spitting into the wind (if there's low inflation then your investment is a dead weight; and if there is a major inflation, then the rest of your portfolio is steamrolled). And it feels too risky to buy a large amount. I like the idea of commodities, but for the reasons mentioned I find it hard to pull the trigger.

The 170th anniversary of the gold-find at Sutter's Mill comes up this week. I hope someone responds to the OP with a good explanation of how to buy commodities for protection against inflation and rising rates - - they may start a Boglehead gold rush!

heyyou
Posts: 3064
Joined: Tue Feb 20, 2007 4:58 pm

Re: Commodities for rising interest rates

Post by heyyou » Mon Jan 22, 2018 10:33 pm

Commodities would have worked well in the high inflation period that was based on expensive oil prices, but not since then. Look at a price chart for PCRIX.

Rising interest rates from near zero to very low single digit amounts could be viewed at returning towards normal rates, or reported by the media as DOUBLING! from recent levels. Both are correct, but only the second one needs to have attention getting headlines every new day. Wake me up when CD rates reach 6-8% again.

I suppose that commodities will someday be at the right place, at the right time, again, but I would have done much better by just adapting to my recent asset amount or recent income, instead of trying to allocate for every possible contingency. Although never a Marine, their "Improvise, Adapt, Overcome" suggests expecting to need to be flexible in the future, the opposite of allocation gymnastics of trying to prepare for every conceivable event.

Inflation buffers could include owning your residence in a reasonably priced area, a paid off car, eating right and exercising to stay healthy longer, and having some discretionary spending in your retirement budget to absorb unplanned expenses.

Some history: After WWI, France built the Maginot Line of fortified positions on their German border to prevent another invasion from there. At the start of WWII, the Germans quickly drove their tanks through Belgium to its unfortified border with France, bypassing the Maginot Line.

The future is often slightly different from the past, just enough to not fit what can now can be seen as the best prep for the previous episode.

lack_ey
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Re: Commodities for rising interest rates

Post by lack_ey » Mon Jan 22, 2018 10:56 pm

Over the last several business cycles, commodity futures have on average been good in late expansion, near the end when things are overheating, which is generally around the time rates have to be cranked up, right before the recession. That said, recessions happen for different reasons, and the economy is maybe not as dependent on commodity prices as before. This Fed tightening has been relatively slow, and productivity growth is not what it used to be.

So I don't know and will punt on the question as well.

not4me
Posts: 387
Joined: Thu May 25, 2017 3:08 pm

Re: Commodities for rising interest rates

Post by not4me » Tue Jan 23, 2018 9:02 am

I'll start with echoing Beehave....not an expert here, but I do have an opinion. I'll try to stay targeted on OPs original question & not stray into whether it is appropriate to change current strategy or how it might be effected.

I would not think it prudent to look solely at interest rate changes to determine changes in commodities. I think the economic environment that causes interest rates to change MAY also have an affect on commodities. But there are multiple factors at work there & possibly others have a more direct affect. For example, if you try to look at past inflation & don't distinguish between "wage inflation" & "commodity inflation", then the period of time you are looking at won't yield useful results in this case.

The strength of the US dollar may be a more direct indicator. Granted, I'm of the opinion that changes in interest rates & dollar strength aren't isolated from each other (others I know disagree). Consider the US dollar playing the role it does as a reserve currency & commodities being priced in US dollars "frequently", much of commodities coming from emerging countries, etc.

At a fundamental level, supply & demand drive price. So, when interest rates are rising (price for bonds is falling), it seems to me that means the supply is increasing relative to the demand for bonds. Did supply increase? demand decrease? Is it disproportionate to the US (that is, will it affect currency exchange rates)? What affect does this have for the supply/demand of a commodity?

I'm of the opinion that the last decade has not been "typical", so I would certainly caution drawing too may conclusions from recent performance. Even looking at a broad index may be misleading. Todays index may be dominated by FANG+ which are less (I think) commodity intensive) than in the past when a Exxon, General Motors, etc were heavy hitters.

Lastly, I think when money is made in commodities it is when you buy low or consistently as part of overall plan -- meaning there isn't a 20 year chart showing zooming performance. Also, I wouldn't look at commodities as standalone, but how they perform in relation to the rest of your portfolio. You didn't really say if you were considering an investment, but if you do I wish you luck!

staythecourse
Posts: 5812
Joined: Mon Jan 03, 2011 9:40 am

Re: Commodities for rising interest rates

Post by staythecourse » Tue Jan 23, 2018 9:11 am

Commodities (CCF) are sold on the futures market (Chicago) and without going into significant detail are sold as a derivative. Basically, the derivative price ends up getting closer and closer to the spot price as the call date arrives. So for one to make money you are waiting for a situation of UNEXPECTED inflation to throw of the derivative price to the actual price (backwardation) to make a profit on the rollover to the next future contract. Vanguard has a paper confirming the usefulness of CCF for SHORT TERM (think 3 months), UNEXPECTED inflation only. Makes sense as the time of unexepected inflation exists the more the market get efficient in predicting future price.

So, in the end I don't think it good decision to add CCF for that reason.

Advice is to read Vanguard's paper I described above on unexpected inflation hedges. In the end, I think the BEST hedge for inflation is stocks and time. If you want something else I would do TIPS.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

Valuethinker
Posts: 35317
Joined: Fri May 11, 2007 11:07 am

Re: Commodities for rising interest rates

Post by Valuethinker » Tue Jan 23, 2018 10:25 am

heyyou wrote:
Mon Jan 22, 2018 10:33 pm


Some history: After WWI, France built the Maginot Line of fortified positions on their German border to prevent another invasion from there. At the start of WWII, the Germans quickly drove their tanks through Belgium to its unfortified border with France, bypassing the Maginot Line.

The future is often slightly different from the past, just enough to not fit what can now can be seen as the best prep for the previous episode.
The point you make is absolutely true, but the historical analogy is a bit inexact. :sharebeer

Sorry you've triggered the military historian in me ;-).

That was the Von Moltke plan (1914). Sweep through Belgium. It caught the Allies somewhat by surprise (although the Belgian fortifications were there, and manned), but the limitations of technology of the time (foot and horse beyond the railheads) meant the Germans just could not execute it fast enough.

The German plan was to repeat this, then in January of 1940, during the Sitzkrieg or Phoney War, a plane carrying the German plan crashed in Belgium. The Belgians, still officially neutral, supplied it to the Allies.

Hitler, enraged, ordered the adoption of a new plan -- the Schlieffen Plan. Which was to go through the Ardennes Forest (later scene of the Battle of the Bulge-- see Taylor Larrimore's war experience Xmas Day 1944) which was "impassable" to tanks, and cross the Meuse River at Sedan, and instead of swinging left towards Paris (1914 plan) swing right towards the Channel, cutting off the Belgians, the French 7th Army and the British Expeditionary Force.

Effectively the middle of the French line, the extension to the Maginot Line along the Luxembourg border.

French cavalry (tank) units were brushed aside in the Ardennes, and the extension of the Maginot Line along the Meuse River was thinly defended, and the French did not have adequate reserves of armoured divisions for the counterattack-- they were frittered away. Only a British tank attack at Arras, by 2 battalions (launched from the shadows of the Canadian WW1 War Monument) managed to actually frighten the Germans (although they were terrified at the pace Rommel and Guderian were setting at the spearheads). The British and many French were eventually evacuated in the "miracle of Dunkirk" leaving their equipment behind. France surrendered several weeks later (the British had reinforced them in the meantime).

So we'd have to say the Maginot Line worked in 1940, in that it prevented the Germans from making a frontal assault on France. However the 1914 plan was then not executed-- they chose a 3rd Option.

It worked brilliantly, but persuaded Hitler that he was a military genius who could ignore his generals' advice. Thus setting the stage for the catastrophe that was Barbarossa, the German invasion of USSR in June 1941, the bloodiest campaign in human history (so far).
Last edited by Valuethinker on Tue Jan 23, 2018 10:29 am, edited 1 time in total.

Valuethinker
Posts: 35317
Joined: Fri May 11, 2007 11:07 am

Re: Commodities for rising interest rates

Post by Valuethinker » Tue Jan 23, 2018 10:27 am

staythecourse wrote:
Tue Jan 23, 2018 9:11 am
Commodities (CCF) are sold on the futures market (Chicago) and without going into significant detail are sold as a derivative. Basically, the derivative price ends up getting closer and closer to the spot price as the call date arrives. So for one to make money you are waiting for a situation of UNEXPECTED inflation to throw of the derivative price to the actual price (backwardation) to make a profit on the rollover to the next future contract. Vanguard has a paper confirming the usefulness of CCF for SHORT TERM (think 3 months), UNEXPECTED inflation only. Makes sense as the time of unexepected inflation exists the more the market get efficient in predicting future price.

So, in the end I don't think it good decision to add CCF for that reason.

Advice is to read Vanguard's paper I described above on unexpected inflation hedges. In the end, I think the BEST hedge for inflation is stocks and time. If you want something else I would do TIPS.

Good luck.
All good stuff and thank you-- informative.

I would add that Commercial Real Estate is held to have a higher correlation with inflation than stocks:

- commercial rents tend to rise with inflation
- although buildings depreciate, land tends to increase in value with inflation

Because there are secular cycles in CRE (I observe about a 14 year boom to bust period, but there are also things like the problems of the shopping mall now) that may be a stronger driver of returns. Also the value of commercial buildings is sensitive to interest rates-- Cap Rates (NOI/ Value) of buildings tend to vary inversely with interest rates. Probably, at the heart of it, with *real* interest rates.

Valuethinker
Posts: 35317
Joined: Fri May 11, 2007 11:07 am

Re: Commodities for rising interest rates

Post by Valuethinker » Tue Jan 23, 2018 10:32 am

heyyou wrote:
Mon Jan 22, 2018 10:33 pm
Commodities would have worked well in the high inflation period that was based on expensive oil prices, but not since then. Look at a price chart for PCRIX.

Rising interest rates from near zero to very low single digit amounts could be viewed at returning towards normal rates, or reported by the media as DOUBLING! from recent levels. Both are correct, but only the second one needs to have attention getting headlines every new day. Wake me up when CD rates reach 6-8% again.
The effects on financial markets of 5% interest rates will be dramatic enough. This is Hyman Minsky again. A long period of stability, led by exceptionally low interest rates, means risk-taking has increased (spreads over A grade corporate bonds, cov lite lending etc.).

What really matters to us long term as investors is real interest rates. 6-8% CD rates on 6-8% inflation would not be a great outcome compared to say 4% interest rates on 2% inflation (because we pay tax on our nominal interest rate, not our real rate).

Valuethinker
Posts: 35317
Joined: Fri May 11, 2007 11:07 am

Re: Commodities for rising interest rates

Post by Valuethinker » Tue Jan 23, 2018 10:33 am

Beehave wrote:
Mon Jan 22, 2018 1:28 pm
I'm no expert, but I have an opinion... :?

There are many ways to obtain and hold commodities -- buy ETF precious metal equivalents, buy mining stocks, buy the metals, invest with hedgers.

Each has costs and risks and high volatility. You can parse them this way and that, but my opinion is that when push comes to shove, if you are buying for inflation protection, if you simply invest a small amount you are spitting into the wind (if there's low inflation then your investment is a dead weight; and if there is a major inflation, then the rest of your portfolio is steamrolled). And it feels too risky to buy a large amount. I like the idea of commodities, but for the reasons mentioned I find it hard to pull the trigger.

The 170th anniversary of the gold-find at Sutter's Mill comes up this week. I hope someone responds to the OP with a good explanation of how to buy commodities for protection against inflation and rising rates - - they may start a Boglehead gold rush!
As a hedging instrument, if the correlation is there, high volatility is a good thing.

You can achieve meaningful total portfolio hedging with a smaller position.

Valuethinker
Posts: 35317
Joined: Fri May 11, 2007 11:07 am

Re: Commodities for rising interest rates

Post by Valuethinker » Tue Jan 23, 2018 10:35 am

Zach82 wrote:
Mon Jan 22, 2018 10:33 am
I am wondering if the better informed here have opinions on what commodities may do in a rising interest rate environment?

Thanks,
Zach
Commodities tend to move up when real interest rates (roughly real = nominal - expected inflation) are low. Commodity positions are financed, and thus a low cost of borrowing tends to push prices of commodities up.

Conversely, when the economy is tight and inflationary pressures are rising, interest rates tend to go up, but so do commodity prices.

I don't think there is a definitive way of knowing which way it will go.

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