Home Commodities Rising Inflation and War in Ukraine Push Investors Into Commodity ETFs

Rising Inflation and War in Ukraine Push Investors Into Commodity ETFs

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Investors spooked by inflation, geopolitical risk and volatility in the stock market are flocking to commodity ETFs to diversify and hedge their portfolios.

So far in 2022, through the end of April, $21.4 billion has flowed into exchange-traded funds in this sector, in contrast to the $6.3 billion in net outflows during the same period in 2021, according to Morningstar Direct. There are now 122 commodity ETFs, up from 112 last year.

Unsurprisingly, gold and other precious-metals ETFs did best, attracting 57.5% of all positive inflows in the commodities category, according to CFRA, an independent markets research and analytics firm. Precious-metals ETFs are seen as a haven against inflation, which is running at the highest rate in 40 years. The most popular was

SPDR Gold Shares

ETF (GLD). It had inflows of $7.4 billion, boosting total net assets to about $67 billion. The fund had year-to-date returns through April 29 of 4.8%, and one-year returns of about 8%. Diversified commodity ETFs were second, garnering 33.7% of the total commodity net flows, followed by agriculture with 7.5% and industrial metals with 1.2%, CFRA reports.

“Historically, commodities offer the best protection against rising inflation compared to equities and other asset classes,” says

Jim Wiederhold,

associate director of commodities and real assets at S&P Dow Jones Indices. “And they tend to rise during times of geopolitical risk. We see this happening in real time as the Ukraine-Russia War rages on.”

Crushing expectations

Loading corn on to a ship in the Black Sea port of Constanta, Romania, in May. Ukraine is one of the world’s main exporters of the commodity.



Photo:

daniel mihailescu/Agence France-Presse/Getty Images

The S&P Global GSCI—a benchmark of 24 commodities in agriculture, energy and metals—had a total return of 39.9% through the end of April, while the S&P 500 fell 12.9%. The commodity index’s rally is a continuation of last year, when a 40.4% surge far exceeded expectations.

Commodities Rising

Commodity performance versus the S&P is no contest since January 2021.

S&P U.S. Aggregate Bond Index

At the same time, commodities have also outflanked fixed-income securities. The S&P U.S. Aggregate Bond Index declined 8.87% through the end of April as rising rates hammered bond prices.

“We are now in the early innings of the next commodity supercycle due to supply and demand imbalances,” says

Jason Bloom,

head of fixed income and alternative ETF strategy for Invesco. Forces at work, he says, include the move away from fossil fuels, investors’ focus on climate change, and the war in Ukraine. All three factors are causing supply scarcity for oil and natural gas, metals, grains and other agricultural commodities, Mr. Bloom says.

“The phenomenon should persist at least through year-end, so the outlook for commodity investments is strong,” says

Aniket Ullal,

vice president and head of ETF data and analytics at CFRA. “Even if the conflict in Ukraine ends, there are so many implications that need to be resolved that will keep commodity prices elevated.”

Ukraine is one of the world’s main exporters of wheat, corn and other grains, and animal and vegetable oils. It is also a supplier of iron ore, steel and potash used in fertilizer. The war has interrupted the country’s planting and agricultural production. The resulting crimp in supply should cause a further rise in agricultural commodity prices in the months ahead. At the same time, the war is exacerbating the rise in oil and gas prices as the U.S. and other countries stop energy imports from Russia. Even before the war, global demand for oil and gas was outstripping supply.

A more-diversified approach

The No. 2 in net inflows, diversified commodity ETFs, according to market analysts and investment strategists, did well by investing in futures contracts of everything from aluminum, copper and wheat to natural gas. The largest fund in this category,

Invesco Optimum Yield Diversified Commodity Strategy No K-1

ETF (PDBC), has attracted inflows of $3.6 billion in the past 12 months. The $8.85 billion fund has a return of 33.5% so far this year through April 29, and a one-year return of 53.5%.

Diversified commodity ETFs invest in baskets of commodities to lower the effects of market volatility on one particular sector, says

Gargi Chaudhuri,

head of iShares Investment Strategy Americas at

BlackRock.

“This is important,” she says, “since commodities are more volatile than equities, and diversification helps lower risk of wild price swings in one asset due to any demand shock.”

One strategy popular among investors in the so-called environmental, social and governance space is combining a diversified agriculture ETF with a specialty metal ETF. The latter segment is especially attractive to investors who want to ride the trend to support green energy.

Funds are now available that invest in metals that go into Teslas and other electric vehicles.



Photo:

Cfoto/DDP/Zuma Press

“Specialty metals such as lithium, copper, aluminum and nickel are used in electric vehicles,” says Mr. Bloom. In response to investor demand, the S&P GSCI Electric Vehicle Metals Index was launched in March. It is a commodities futures-based index designed to reflect the performance of tradable metals used in the production of an electric vehicle. The current mix: nickel (36.73%); copper (27.3%); aluminum (17.72%); cobalt (9.9%); iron ore (8.34%).

Invesco has picked up on the trend, launching an ETF for metals used in electric vehicles in April.

Invesco Electric Vehicle Metals Commodity Strategy No K-1

ETF (EVMT) will hold futures contracts and other financial products tracking such metals as copper, cobalt, nickel and aluminum.

A top-performing specialty-metal fund is the $3.14 billion

SPDR S&P Metals & Mining

ETF (XME). It tracks an index that provides exposure to a broad spectrum of metals and mining companies in the U.S. It has top holdings in

MP Materials,


MP 2.07%

Alcoa,


AA 4.29%

Century Aluminum


CENX 7.67%

and

Royal Gold.


RGLD -0.21%

Year-to-date returns through April 29 were 25.6%, and one-year returns were 37.5%.

A caution

Keep in mind that investing in commodities isn’t for the faint of heart. Commodities are more volatile than stocks. Prices can change on a dime due to many macroeconomic factors such as a supply-chain disruption, a slowdown in economic growth or a recession.

Commodity ETFs come in many varieties. It’s important for individual investors to do their homework and understand the fund’s investment strategy and the makeup of its portfolio.

Some ETFs hold physical commodities, while others hold commodity futures. If you are doing homework on a fund that invests in futures contracts, you might want to check its roll yield. It is the return generated by rolling short-term futures contracts into longer-term contracts. It is also important to track any commodity ETF’s one-year volatility rate as well as its annualized returns.

In the end, any investor must weigh the fund’s volatility risk against its upside potential.

Ms. Ioannou is a writer in New York. She can be reached at reports@wsj.com.

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