2023-07-07 13:23:13 ET
Summary
- The composite of 29 leading commodities rose by 0.21% in Q2 2023, but fell 1.79% over the first half of the year, with the energy sector being the worst-performing.
- Four of the six commodity market sectors declined in Q2, with precious metals leading the decline. However, the animal protein sector led the asset class higher with 18.54% and 18.68% respective gains.
- Despite the overall decline, I maintain a bullish position for the commodities asset class in the second half of 2023 and Invesco DB Commodity Index Tracking Fund ETF.
A composite of the twenty-nine leading commodities that trade on the U.S. and U.K. futures and forward exchanges rose by an anemic 0.21% in the second quarter. Over the first six months of 2023, the composite fell 1.79%. In 2022, the asset class gained 5.37% after a 26.79% increase in 2021 and a 9.89% gain in 2020. Even the most aggressive bull markets rarely move in straight lines.
The highest inflation in four decades fueled the rally in commodities. The tidal wave in central bank liquidity and a tsunami of government stimulus addressing the 2020 global pandemic ignited inflation and launched commodity prices over the past years. Moreover, the pandemic created supply chain bottlenecks, and the war in Ukraine and the bifurcation of the world's nuclear powers created supply chain issues that caused many commodities to rise to multi-year or all-time highs.
In March 2022, the U.S. central bank began increasing the Fed Funds Rate and tightening credit further out along the yield curve. The Fed Funds Rate has risen to a midpoint of 5.125%, with quantitative tightening continuing to reduce the U.S. central bank's balance sheet. Other central banks have followed the Fed with hawkish monetary policies.
Rising interest rates increase the cost of carrying commodity inventories and often weigh on prices, which have declined over the first six months of 2023. The Invesco DB Commodity Index Tracking Fund ETF ( DBC ) tracks commodity prices, with a weighting toward energy prices.
More losers than winners in Q2
Four of the six commodity market sectors declined in the second quarter, with precious metals leading the way on the downside:
- The precious metals composite fell 8.34% in Q2 and was 11.81% lower over the first six months of 2023.
- The base metals composite dropped 7.51% in Q2 and posted a 9.43% loss over the first half of this year.
- The grain and oilseed sector declined 2.69% in Q2 and was 6.54% below the December 30, 2022, closing level on June 30, 2023.
- The energy sector edged only 0.53% lower in Q2 but was the worst-performing commodity market sector since the end of 2022, with a 14.44% loss.
The sectors that moved higher in Q2 include:
- The soft commodities sector, with a 1.79% Q2 gain and a 13.34% increase over the first six months of this year.
- The animal protein sector led the asset class higher in Q2 and the first half of the year, with 18.54% and 18.68% respective gains.
Of forty individual commodities and commodity-related markets, thirteen posted gains in Q2, and twenty-seven moved to the downside. Losers outnumbered winners over the first half of 2023, with sixteen moving higher and twenty-four moving lower.
The asset class leaders
From March 30 through June 30, 2023, five commodity markets posted double-digit percentage gains:
Gains in Individual Commodities in Q2 2023 (Prepared spreadsheet from closing prices on June 30, 2023)
Gains in lean hogs and feeder cattle caused animal proteins to lead the way on the upside in Q2. Natural gas's over 26% gain stabilized the energy sector, which only experienced a marginal decline. Over the first six months of this year, six commodities moved over 10% higher, with three posting more than 30% gains:
Gains in Individual Commodities Over the First Six Months of 2023 (Prepared spreadsheet from closing prices on June 30, 2023)
The U.S. 30-Year bond futures fell 3.49% in Q2, and higher interest rates weighed on commodity prices, causing losers to outnumber winners over the three months.
The asset class losers
From March 30 through June 30, 2023, nine commodity markets posted double-digit percentage losses:
Commodities Posting Losses in Q2 2023 (Prepared spreadsheet from closing prices on June 30, 2023)
While rhodium and the Baltic Dry Index posted the worst losses, they do not trade on the futures or forward exchanges. Precious and nonferrous metals accounted for four of the seven markets that experienced double-digit percentage losses, along with corn, coal, and soybean meal.
Sixteen commodities fell more than 10% over the first six months of 2023:
Commodities Posting Losses Over the First Six Months of 2023 (Prepared spreadsheet from closing prices on June 30, 2023)
While the asset class was 0.21% higher in Q2 and down just 1.79% since the end of last year, the price action in individual markets was mostly bearish over the first half of 2023.
DBC is energy-centric
The Invesco DB Commodity Index Tracking Fund is a highly liquid ETF that provides exposure to the raw material asset class. At $22.82 per share on July 7, DBC had $1.94 billion in assets under management. DBC trades an average of over one million shares daily and charges an 0.85% management fee. However, the 14.0 cents annual dividend history translates to a 0.63% yield that covers most of the annual management fee for longer-term holders.
DBC's top holdings include:
As the chart highlights, it holds the greatest percentage of its assets invested in commodities in crude oil and oil product futures. DBC also has smaller long futures positions in metals and agricultural products. DBC is an energy-centric commodity ETF product.
The chart highlights DBC's 4.4% decline from $23.74 on March 30, 2023, to $22.70 on June 30, 2023. Over the first six months, DBC fell 7.9% from $24.65 to $22.70.
DBC underperformed the overall commodity composite that rose 0.21% in Q2 and fell 1.79% over the first two quarters. However, while the energy-centric ETF underperformed the energy sector that fell 0.53% in Q2, it outperformed energy commodities since the end of last year, as they dropped 14.4% over the six months.
The outlook for Q3 and beyond
Markets reflect the economic and geopolitical landscapes. While bonds declined in Q2, sending interest rates higher, all the leading U.S. stock market indices posted impressive gains. The VIX index ended the quarter below the 24 level. Markets are complacent as inflation has declined, and the U.S. economy has yet to slip into a recession.
Meanwhile, the hawkish Fed continues to squawk with inflation well above its 2% target. The stock market is fighting the Fed with recent gains, which could be a mistake. The action in many commodity markets reflects the central bank's commitment to fighting inflation. However, the trajectory of rate hikes will slow, which could cushion the raw materials asset class and result in higher lows in many markets that have been correcting across all sectors.
Energy poses the most interesting potential for upside price action as it was the worst-performing sector over the first half of 2023. The U.S. SPR fell to 347.2 million barrels as of June 30, 2023. In November 2021, the SPR held over 600 million barrels. With the administration's target to purchase petroleum for the SPR at $67-$72 per barrel and the first purchases scheduled for August, the Department of Energy could support oil and oil product prices while OPEC+ continues to trim production.
Meanwhile, unseasonably warm temperatures support natural gas prices, and the end of Q3 will mark the beginning of the peak season for demand as natural gas readies for winter.
De-dollarization among the BRICS countries could support gold, despite the recent central bank sales. Gold suffered a bearish double-top formation on the long-term chart at $2,072 in Q2 and corrected. However, every significant correction in gold since the turn of this century has been a buying opportunity. Copper has declined, but it remains the critical commodity for decarbonization and the leader of the base metals on the London Metals Exchange.
The bifurcation of the world's nuclear powers continues to make the geopolitical landscape dangerous, which could lead to supply chain issues. Russia and Ukraine are leading agricultural producers and exporters, and the ongoing war poses supply challenges.
I maintain a bullish position for the commodities asset class as we head into the second half of 2023. Buying Invesco DB Commodity Index Tracking Fund ETF on a scale-down basis could be the optimal approach for investors and traders seeking long exposure to the volatile asset class as it is weighted towards energy commodities.
For further details see:
DBC: Bearish Quarter For Diversified Commodity ETF, Bullish Future On Horizon