How com­modi­ties help beat in­fla­tion

Finweek English Edition - - INVESTMENT -

As the key in­puts into most goods and many ser vices, com­modi­ties are in­ti­mately re­lated to in­fla­tion. Our anal­y­sis of the com­mod­ity-re­lated com­po­nents of the Con­sumer Price In­dex (CPI) bas­ket shows that 38% of our to­tal monthly ex­pen­di­ture is di­rectly af­fected by com­mod­ity prices (e.g. food, elec­tric­ity and trans­port ser­vices). For the low­est earn­ing 20% of the pop­u­la­tion, its im­pact is even greater – 65% of their in­come is spent on th­ese goods and ser­vices (53% on food alone).

The ex­pe­ri­ence of the Seven­ties clearly shows the po­ten­tial inf la­tion-hedg­ing char­ac­ter­is­tics of this as­set class: dur­ing the pe­riod be­tween 1968 and 1982, in which do­mes­tic inf la­tion av­er­aged 10% per an­num, com­mod­ity prices were up an aver­age of 17% in Rand terms. When com­pared with other as­sets, this re­turn was beaten only by eq­ui­ties, which av­er­aged 18% per an­num over the same pe­riod, al­beit with a slightly higher level of risk (volatil­ity – see graph). Im­por­tantly, how­ever, the low his­toric cor­re­la­tion be­tween eq­ui­ties and com­modi­ties – just 0.27 dur­ing over the pe­riod in ques­tion – sug­gests that there are clear di­ver­si­fi­ca­tion ben­e­fits from com­bin­ing the two.

Un­til now, in­vestors have not been able to in­vest di­rectly into the com­modi­ties that are driv­ing the inf la­tion they ex­pe­ri­ence, as tra­di­tion­ally, in­vest­ing in com­modi­ties has been re­stricted to buy­ing funds or in­dices com­pris­ing com­mod­ity bun­dles which have been con­structed on a some­what ar­bi­trary ba­sis.

In South Africa, for ex­am­ple, the only cur­rently in­vestable com­mod­ity bas­ket – Stan­dard Bank’s African Com­modi­ties In­dex – uses pan-African pro­duc­tion quan­ti­ties to de­ter­mine the weights for their bas­ket of com­modi­ties. Sim­i­larly, within the in­ter­na­tional space, the Thomp­son Reuters Com­mod­ity Re­search Bureau (CRB) In­dex – the old­est es­tab­lished com­modi­ties in­dex in the world – cur­rently com­prises 19 com­modi­ties that are se­lected on the fol­low­ing ba­sis: En­ergy-re­lated com­modi­ties get the high­est al­lo­ca­tion (33% – al­ways); Highly liq­uid (i.e. fre­quently traded) and then less liq­uid com­modi­ties get the next big­gest al­lo­ca­tions; and fi­nally, Those com­modi­ties that pro­vide diver- sifi­ca­tion are also in­cluded. In both cases, nei­ther of th­ese bas­kets re­late to the com­modi­ties that con­sumers are faced with when they pur­chase their goods and ser­vices and are, there­fore, un­likely to be the best hedge against their per­sonal inf la­tion ex­pe­ri­ence.

To over­come this short­fall, we have de­vel­oped for our clients a Com­modi­ties Con­sump­tion In­dex (CCI), which best ref lects the bun­dle of com­modi­ties that con­sumers are most di­rectly ex­posed to through their nor­mal pur­chas­ing be­hav­ior, as mea­sured by the CPI. It is a com­bi­na­tion of six com­modi­ties: oil, coal, maize, wheat, sunf lower and sorghum, all of which are in­di­vid­u­ally avail­able to in­vestors through the South African Fu­tures Ex­change (SAFEX). Un­like other in­dices, our CCI does not in­clude any pre­cious or base met­als which, by virtue of the fact that they are man­u­fac­tur­ing in­puts, are com­po­nents of the Pro­ducer Price In­dex (PPI), rather than the CPI.

Beat­ing inf la­tion is the min­i­mum re­quire­ment for any long-term in­vestor. Our anal­y­sis of the per­for­mance of this bun­dle of con­sump­tion com­modi­ties shows that it has good inf la­tion hedg­ing properties. More­over, its re­turns of­fer di­ver­si­fi­ca­tion ben­e­fits to in­vestors and, in some cases, it can also en­hance the re­turns from a di­ver­si­fied port­fo­lio. Hav­ing di­rect ac­cess to the com­modi­ties that they con­sume is a very in­tu­itive and ef­fec­tive way for in­vestors to pro­tect them­selves against the ef­fects of this in­sid­i­ous ero­sion of the value of their sav­ings.

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