This Commodity Index Would Only Raise Its Exposure To Gold If The U.S. Fell Into A Recession

Monday May 22, 2017 11:12
(Kitco News) - Despite the threat of rising inflation, it would probably take the U.S. falling into a recession before one fund would add more gold into its commodity index, according to one analyst.

In a webinar last week, Geert Rouwenhorst, professor of Finance and deputy director of the International Center for Finance at Yale School of Management said that in an environment of rising prices, he prefers to have a larger exposure to energy assets and industrial metals because they has a higher beta to inflation compared to gold.

Along with his role at Yale, Rouwenhorst is also a partner at SummerHaven Investment Management, which developed the SummerHaven Dynamic Commodity Index. While the index has exposure to all six major commodity sectors, for May, its lowest allocation is in gold, representing about 12% of the total fund. The fund’s gold positon was valued at $37.8 million dollars, as of May 19.

The only reason why gold is included in the index portfolio is because its structure requires exposure to all commodity asset classes.

“Gold is an oddity because it doesn’t follow traditional supply and demand fundamentals,” he said during the webinar. “Gold acts more like a currency than a commodity.”
The scenario, Rouwenhorst said, where gold could have a bigger role in his firm’s Index is if the U.S. fell into a recession. Lower economic activity would lead to lower demand and higher inventories.

The index’s biggest position for the month is in cocoa futures, which was last valued at nearly $37 million.

Rouwenhorst explained that the Index, which is rebalanced monthly, is structured based on market supply and demand fundamentals. The index primarily looks at the commodity sector that the highest backwardation or lowest contango in the marketplace, as this is an indication of growing demand and shrinking inventories. Backwardation is when current future prices are below spot price – indicating that prices will rise as spot and the futures markets converge. At the same time, contango is the scenario where prices are trading higher than the spot price – indicating that prices will fall as the markets converge.

While Rouwenhorst isn’t very bullish on gold, he is extremely optimistic on commodities in general. Not only do broad-based commodities offer better value compared to over-extended bond and equity markets, but the sector historically outperforms other asset classes in a rising inflationary environment.

He added that while inflation is still low compared to historical norms, there are indications that the economy is on the verge of seeing an “inflationary shock,” as price pressures could double in the next few years.

Although in recent history inflation number rose to double digits in the 1980s, a rise now would be a lot more significant because the economy is starting at extremely low levels.

Rouwenhorst noted that commodities are currently in tracking in the lower fifth percentile of their long-term trading ranges, while equities and bonds are trading in the 95th percentiles.

“It’s hard to find asset classes that are cheaper than commodities right now,” he said.

By Neils Christensen
For Kitco News