3 Reasons To Buy Commodity ETFs This Year

Broad commodities have staged a nice comeback lately on tight supply conditions and strong global demand and is likely to maintain the uptrend in the days to come. So far this year (as of Mar 26, 2018), PowerShares DB Commodity Tracking ETF DBC is up 1.7%, all-world equity fund iShares MSCI ACWI ETF ACWI is down 1.4% and SPDR S&P 500 ETF SPY has lost about 1.4%. On the other hand, Vanguard Total Bond Market ETF BND has lost about 2.3%.

Last year, Goldman Sachs forecast commodities should outperform equities and other asset classes this year and rise almost 10%. This is against its previous forecast of 4% returns.

Let's discuss the drivers:

Subdued Greenback

Commodities are linked with the U.S. dollar. Since the currency has been downbeat since last year despite multiple rate hikes by the Federal Reserve and upbeat economic indicators, commodity trading has got a nice lift. PowerShares DB US Dollar Bullish ETF UUP was down about 9% in the last one year (as of Mar 26, 2018).

And the currency is probably on its way to lose more. A Wells Fargo strategist recently noted that more pain for dollar bulls is waiting. The analyst delved a little deeper to analyze the greenback's trend. He noted that over the last 50 years, the greenback has actually maintained a downtrend.

Three factors including considerable U.S. government borrowing, uptick in global economy and the likely end to the European Central Bank's QE policy should keep a lid on the greenback appreciation. Further, President Trump is in favor of keeping the greenback low to enjoy trade advantage. In short, commodity investing should not fear the dollar strength for the rest of the year.

Uptick in Global Growth

Synchronized global growth should translate into higher demand for commodities. The global economy is likely to witness its strongest growth in seven years in 2018 thanks to improving trade and investment. Rising global growth should result in increased activities and demand for commodities. The Chinese economy, the world's biggest consumer of commodities, is also on an uptrend.

China's economy grew 6.9% in 2017 compared with 6.7% in the previous year, marking the first annual acceleration since 2010. The country is also putting immense effort to emerge as a clean energy haven. Since renewable energy infrastructure requires greater use of raw materials like copper and steel, demand for commodities should perk up, per the chief executive of BHP Billiton, quoted on ft.com.

He noted that electrification and decarbonization would continue to boost demand for higher quality raw materials because steel mills and copper smelters result in more efficient technology. In fact, population growth in the developing world and a rise of the urban middle class would be the biggest driver of "demand for energy, metals and fertilizers for decades to come."

Use of Commodities as Inflation Hedge

This asset class is often viewed as an inflation hedge. Commodity prices normally rise when inflation is gathering steam, naturally offering protection from the effects of inflation. Per the latest Fed projections, PCE inflation will remain the same at 1.9% for 2018 and 2% for 2019 but may nudge up to 2.1% (from 2.0% projected earlier) for the year thereafter.

Core PCE inflation for 2019 and 2020 were rasied to 2.1% from 2.0%. So, an inflationary pressure should be felt ahead. As prices for goods will rise, the prices for the needed raw materials (or commodities) will also be steeper.

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