With uncertainty coming in from multiple directions, investing in commodities might be a relevant option for those looking to hedge risks in equities and fixed income.

Time to look for new safe havens?

Given recent market behavior, investors are understandably seeking safe havens amid rising unpredictability and uncertainty. Rapid shifts in policy announcements and market reactions, particularly concerning trade tariffs, have dominated headlines. While the U.S.-China trade deal has eased recession fears, ongoing unpredictable tariff declarations indicate that this situation is far from resolved. Economic instability is expected to continue affecting growth, keeping sentiment cautious. Policy shocks are still likely, and confidence has been shaken, evidenced by the U.S. treasury market's unusual behavior akin to equities for a moment in April. Moody's downgrade of the U.S. credit rating from Aaa to Aa1, has added to concerns that the U.S. may not be the safe haven it once was.

Could commodities offer some protection in this uncertain environment? There are opportunities, but investors should step carefully. Risks remain, as reflected by the divergence in commodity prices.. Trade tensions have not disappeared, as seen by U.S. announcements of possibly higher European tariffs. Any collapse in trade would see significant downward pressure on base metal demand and prices as activity slows.

Energy down

The oil price is down 15% over the first four months of the year, reflecting a mix of increased supply and weaker demand. There have been expectations of a supply increase from greater Organization of Petroleum Export Countries (OPEC) production, with the group reportedly considering an output hike for July, possibly in an attempt to maintain market share.

In the U.S., the government has made overtures of increasing production and reducing regulation, which would only add to supply and further drive prices down. Efforts to reduce inflation to soften the impact of tariffs in the U.S. also suggest that lower energy prices are a favorable outcome.

On the demand side, concerns about global trade activity will continue to exert downward pressure, although this will fluctuate based on the result of the trade/tariff announcements. Oil prices might see an added risk premium in the price due to geopolitical tensions, with potential events surrounding the conflict in the Middle East and Russia still possible. 

Gold up

One commodity that has grabbed attention due to its positive performance is gold. Gold offers several advantages as an investment. One of its key benefits is its low correlation with equities and bonds. Over the last five years, the correlation coefficient between the return of gold and a portfolio of 60% in the S&P 500 and 40% in the Bloomberg U.S. aggregate is 0.13. Over the last year, the correlation has shifted to being around -0.4, making it an effective tool for diversifying investment portfolios. Unlike other metals such as copper and steel, the use of gold is not confined to industrial applications, which can shield it from tariffs that affect many other materials in today's market. Additionally, gold is not solely driven by supply and demand, nor is it heavily influenced by geopolitical factors like oil. While gold does not generate yield or income, this characteristic provides some stability against geopolitical upheavals and stability against inflation and lower interest rates. 

But has gold peaked?

Typically, these features make gold particularly valuable in uncertain environments with declining interest rates, which aligns well with the current global events. However, the relatively strong performance of gold, which is up around 25% year-to-date , has raised questions of whether it has peaked. 

Historically, gold prices have been strongly negatively correlated with real yields, as earning no income is preferable to negative income in real terms. However, since 2022, around the time of the Russia-Ukraine conflict, this relationship has changed (Exhibit 1) for several reasons. One reason is that emerging market central banks have increased their gold purchases to diversify away from the U.S. dollar and U.S. treasuries holdings in recent years (Exhibit 2). More recently the direction of U.S. policy and conviction in U.S. assets may have reinforced this view. Given the policy uncertainty in the U.S. and rising concerns over U.S. debt and deficit levels, this trend may continue, providing some support for gold prices. 

Investment implications

Commodities should remain a useful investment tool for diversification. Some commodities will still be heavily driven by supply and demand, along with the continually evolving global trade outlook. If the global outlook worsens with trade negotiations between the U.S. and other economies deteriorating and confidence in the safe haven status of the U.S. dollar and U.S. treasuries wanes, we believe gold could serve as a useful tool for investor portfolios to hedge against slowing global growth amid policy risks. However, while gold may have a role to play in a portfolio as a hedge in times of heighted uncertainty, investors should be sensitive to the size of that position and expectations for higher prices given the strong performance in recent years. 

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