[INTRO]
HUSSEIN: The commodity market has been starved of capital for the last 10 to 12 years. So the commodities that are the most supply inelastic, I think, will continue to remain interesting.
[MUSIC PLAYING]
INGRID: Welcome to the TDAM Talks Podcast. Today, we're going to take a look back at a wild year in commodity investing. From record highs to unexpected drops, the commodities market has been keeping everyone on their toes.
So in this episode, we're going to look at the political and economic impact on the commodities market after a surprise election and explore the wild price swings in commodities, such as oil, gold, agriculture, and more. I am your host, Ingrid McIntosh, and with me, I have returning guest and Head of Commodities, Hussein Allidina. Hello.
HUSSEIN: Hey, Ingrid. Thanks for having me back.
INGRID: Also joining us to provide us expert opinion, we have Humza Hussein, a member of our commodities team with a specific focus on the agricultural sector. Thank you for joining us, Humza.
HUMZA: Hi, Ingrid. Thank you for having me.
INGRID: OK, so I promise to look back over the year, but how about we do a look back over the month? Trump has just won the election, and commodities prices have dropped immediately. Can you put this in perspective, and what should we be thinking about? What should our investors and advisors be thinking about?
HUSSEIN: Sure, I can try to. So commodities, I guess from the close last Tuesday, when it became apparent that there was going to be a Trump win and potentially a red sweep, commodities, as measured by the Bloomberg Commodity Index, are off about 200 basis points.
I think the weakness has been most pronounced in precious metals, gold, silver, and then to a lesser extent, the base metals and a bit of a drag in energy. I think the biggest driver, Ingrid, of that weakness, is primarily the strength in the US dollar that we're seeing following Trump's victory.
The dollar is trading-- as measured by the DXY, it's trading at a one-year high. And again, all of the commodities, most of the commodities that we invest in, are priced in dollars, so that's acted as a headwind.
I think there is some concern about the magnitude of the tariffs that he imposes in his first 100 days in office and what that might mean for China, in particular, and China's metals demand. And I think that's why we're seeing some base metals weakness as well. Ultimately, though, I do think that his policy is going to continue to lift the level of deficit in the US, the level of debt globally and particularly in the US. And I think ultimately, that's good for real assets, commodities included.
INGRID: OK, so there's the short-term and the long-term. Let's take a look back over 2024, which I think was a really interesting year for commodity investing. I want to dive down a little bit. First, can we talk about gold? Because prior to, as you said, the last week or two, it's had a real run up in prices here. What's been going on?
HUSSEIN: So I think gold is super interesting. I think over the course of the last 16, 24 months, you've seen gold perform remarkably well, better than any of the other commodities, and arguably better than the S&P on a five-year view. And I think that is primarily a reflection of robust central bank buying. Emerging market central banks have been buying record amounts of gold to diversify their reserves. And of late, June, July, August, you've seen interest from investors.
So if you look at non-commercial positioning or speculative positioning, guys have started to add exposure to gold. Notwithstanding the fact that we've pulled back by about $150 an ounce since the Trump win and the strength in the US dollar, we still like gold quite a bit and remain overweight in our portfolio.
INGRID: So metals generally are about a third of the index, and gold's about half of that. What about the rest of the metal sector? How should we be thinking about that?
HUMZA: For this year, they're flat on the year, so copper and aluminum both up slightly. But I think the long-term story is there. I think the long-term story for both copper and aluminum, if we're talking about energy transition, if we're talking about EVs, the demand is going to be there for the next 10 years. And the supply isn't. It might be the sector of commodities that leads the way for the next 10 years.
INGRID: Well, you've touched on EVs right there. And I think when people think about the EV trade, they think about the energy sector. Can we talk a little bit about the year that was? And then again, let's pivot back to the Trump win and what that might mean for that section of the commodities market.
HUSSEIN: So I think on the EV front, there's a lot of debate discussion right now about Trump and what that means for the US's EV policy going forward. I think it gets a little bit potentially confusing when we see great Elon next to Trump, the champion of EV.
I think if we zoom out, Ingrid, and take a look at globally what's happening with EV penetration, the US was a first adopter, let's say, in EV. But China and the rest of the world, China, in particular, has eclipsed as far as the number of units, the pace of penetration.
Zoom out a little bit, and notwithstanding the focus on EV, we still sell-- for every 10 or 12 EVs we're selling, we're still selling 80 odd ICE vehicles, Internal Combustion Engines. So we need both. And I think we will see policies evolve over the course of presumably the next 100, 150 days as Trump takes office.
But ultimately, if we look at economic growth, if economic growth continues to increase, particularly from low levels, you're seeing people purchase cars for the first time. And again, 8 out of 10 are still combustible engines, ICE vehicles. I think you need both.
And I think part of the reason that we're constructive on the metals, as Humza mentioned, is because the EV vehicle requires copper alloy. But more importantly, you need to be able to move power from Ontario Hydrow or whoever your provider is. And that's very metals intensive. And we have not invested over the course over the last 10, 12 years in commodities broadly. And that's a particular concern for the metals because they take a very long time to come to market.
INGRID: And I think that when people look at the trade or the commodities trade, they look at the jurisdictions that are saying, we're going to mandate EV production. We're going to say, and by x date, this percentage of car production will be EVs. Is that just too aspirational? What would the commodities markets say about our ability to deliver that?
HUSSEIN: I think it's really, really important to have these sort of stretch targets. I think the reality, though, is we'll probably be disappointed relative to our expectations. And that has to do with the physical constraints.
INGRID: Yeah, it's not people's purchasing bias. It is?
HUSSEIN: Part of it is purchasing bias as well. So I'm faced with the choice of buying a far more expensive electric vehicle or buying a cheaper, more economic gasoline vehicle. The other challenge that I have is even if that consumption was subsidized-- let's say the government decided that they would give everyone an EV vehicle, which would potentially create havoc to deficits, debt, et cetera. But in that environment, we haven't built power generation capacity. If you look in the US or in North America, our power demand for the better part of the last two decades has been flat.
As we move away from conventional vehicles to Teslas and BYDs, we have to build power generation capacity. That is extremely constructive base metals demand because the power lines look like it's rubber, but there's copper inside of them. And we haven't invested on the supply side.
INGRID: Yeah. Aspirational, but hard to achieve. OK, we've talked about metals a little bit. We've talked about oil and energy. Let's talk a little bit what I call the Breakfast Club, so coffee, cocoa, sugar. What's been going on there? How do we think about that?
HUMZA: So the inelasticity of supply is what drives the commodity cycles. And I think the agricultural sector has been very interesting because it led the way in terms of performance this year, but it was also the biggest drag.
So if you look at the agriculture sector, there are the traditional crops, the annual crops of corn, soybeans, wheat. And because they're annual, we had a price spike a few years ago, and now you're seeing that supply response, which is pressuring prices. And so that sector of commodities was actually the biggest drag this year. It was down 20%.
On the other hand, you have this subsector of agriculture products, which are the soft commodities. So these are things like coffee, cocoa, sugar, not the traditional crops that you think of. And these are perennial crops that have much longer lead times. So it takes many years to bring those crops into production.
And so now we're reaping the consequences of a lack of investment over the previous decade. And so growth has grown, and the growth in all these commodities grows year after year, whereas the supply is now trying to catch up. And it's going to take several years.
So, coffee was up 45% this year after being up 25% the year before because it takes many years to bring these online. It takes three to five years to bring on new coffee trees, new cocoa trees, new sugar cane. And so that's where we are. That's the interesting part of commodities this year.
INGRID: So we at TDAM are one of the very few asset managers, if not the only Canadian asset manager, to have a pure commodities investing vehicle strategy. So we offer a standalone vehicle, and we also invest that in our asset allocation solutions as well.
So first of all, maybe, can we take a look at the strategy? How did it do this year? How did the commodities market overall do? And what was really working or not working for us?
HUSSEIN: So, TD's decision several years ago to build out a commodity effort, I think, was predicated on leadership's recognition that portfolio construction is optimized with the inclusion of commodities. We've talked before, Ingrid, about the diversification, the inflation protection that commodities provide.
And in the context of the portfolio, the addition of commodities at a 5% to 10% allocation is accretive and improves your efficient frontier. Your question specifically on what the asset class has done this year, the benchmark, the Bloomberg Commodity Index, is up about 2%, 2.1% year to date, and we've outperformed that in our strategy by about 100 basis points.
We have underperformed equities. Clearly, if I was long NVIDIA, I would have outperformed the 3% the benchmark is up. But I think it's very important to appreciate that in the context of portfolio construction, in a year where inflation expectations have receded, commodities have done exactly what they're supposed to do in the portfolio.
So I've reduced the overall risk of my portfolio by having this 5% to 10% allocation. Yes, I've sacrificed returns. If I was long, again, NVIDIA, I would have outperformed but that's not portfolio construction.
INGRID: So then in this strategy, what was really working for us? What was helping you garner that value added relative to that commodities landscape?
HUMZA: So we were overweight precious metals. So, we definitely rode the wave in gold. And we were underweight AGS. And we also were very tactical with our copper positions. So that's where we generated most of our alpha.
INGRID: What about the investor who says that they can invest in commodities on their own? They can call the market in one of the commodities. What else does investing in a dedicated vehicle like this bring to the investor?
HUSSEIN: There's two pieces there, Ingrid. The investor potentially could call the market. And I think that's great if they can. I come from the institutional landscape, and we were very committed to having a allocation because we believe that we were smart enough to realize that we don't know what macro environment we're going to be in tomorrow. We don't know what inflation will look like. We don't know what growth will look like. So let's build an all weather or a optimal portfolio. And that portfolio includes an allocation to commodities through time.
The other piece about replicating that exposure. So if you think about the benchmark, the Bloomberg Commodity Index, which is the benchmark of our strategy, that's 26 different commodities. It's not a buy and hold strategy. It's not like building a basket of 26 equities.
I have to roll these futures. We have to roll these futures every month. So between the fifth and ninth business day, we're rolling 20% of your exposure from the prompt contract to the next month contract. If we don't do that, then lean hogs and barrels of oil show up at your house. That doesn't work.
INGRID: It's not a trade error that I wanted.
HUSSEIN: No. So it's not that you can't do it yourself. You could do it yourself, but there is a cost associated with doing that, and it's not, again, as straightforward as just buying a basket of 20 names and holding them into perpetuity.
INGRID: We've also talked about this. What about the investor that's sitting in cash when you actually have a cash-like exposure here now, too?
HUSSEIN: Yeah. So the returns come not just from the move in the underlying price of the commodity or the shape of the curve, but it also comes from the collateral yield. When you invest in our fund, we don't need a $100 of exposure to get you a $100 of commodity exposure.
I don't need $100 of notional to get $100 of commodity exposure. I need $1,215. The other $80 is sitting today in T-bills, earning you 4% and change, almost 5%. So there's a bit of a fixed income component, you could argue, by nature of how derivatives work.
INGRID: I think that's the question that we always ask. So if an investor was looking to add an allocation to commodities within a diversified portfolio, where should they take that allocation from?
HUSSEIN: So I think we've seen investors reduce, for example, their exposure to Canadian equities as a way of garnering the true commodity beta exposure. A lot of folks historically have had this dirty proxy through the commodity equities.
Of late, we've seen folks reduce their fixed income exposure. I think it's very, very difficult, frankly, to be underweight equities here, given what we're seeing happen in the US and given what we're seeing happen globally as it relates to monetary policy. Things are loosening, which should be good for growth. So hard to be underweight equities.
I think it's a lot harder to be involved in fixed income right now. It's not clear to me that the increase in debt deficits are not going to continue to push up term premia and increase yields. We've seen it, of course, over the course of the last several weeks. Today, I think I'd probably reduce my fixed income exposure and add commodities.
HUMZA: And I think we've taken it for granted that bonds are negatively correlated with equities. And it has been for the last two decades, but it's been in a period where you have low growth, low rates, low inflation. I think the last few years have changed that.
And I think if you look back the last 100 years, most of the time, 70 out of those last 100 years, including the last three, bonds and equities have been positively correlated. So you're losing that diversification benefits of bonds. And now, maybe it's time to think about using commodities as that diversifier.
The other point I would add is it's the same reason why gold is doing really, really well. I think there's an idea of debasement. And that's why in that kind of regime, maybe you want to shift more towards real assets. And bonds are not a real asset, whereas commodities are more of a real asset.
INGRID: So as you look forward into 2025 and you look at the commodities landscape, what areas, just for our listeners, are you the most optimistic about in that commodities? Is there a place of worry? What's your outlook for 2025?
HUSSEIN: I think there's going to be a lot of noise and quite a bit of volatility, particularly around the first quarter of next year, as we see President Trump and his administration release their various policies.
When we look at the fundamentals, the commodities-- and Humza talked about this a little bit-- the commodity market has been starved of capital for the last 10 to 12 years. So the commodities that are the most supply inelastic, I think, will continue to remain interesting, so your metals in particular.
If I get reasonable growth out of the US and China, if I don't see a material increase in trade tensions, the metals should outperform. If not in '25, Humza mentioned that over the course of the next 10 years, we're most constructive, the metals.
Heading into 2025, I think risk-reward in oil looks far better than the market is discounting. There's been a lot of discussion around Trump's "Drill, baby, drill." The market is not focused, however, on the potential for Iranian and Russian barrels to actually be sanctioned.
Iran has contributed about 1.2 to 1.3 million barrels a day of incremental exports over the course of the last 16 months, 24 months. That's more than a year's global oil demand. It's not trivial. We're focused, or the market's focused on this idea of "Drill, baby, drill."
US producers are already producing record volumes. Despite the rhetoric from the Biden administration, US production grew unabated. And it's not clear to me or to us that we're going to be able to see a meaningful increase, at least in 2025, out of the US, irrespective of what Trump does. So we think risk-reward in energy is good. Maybe I can leave it to the expert to talk on the grains and softs.
HUMZA: So I mean, we're starting to see the initial response in the soft sector, but we haven't completed that three to five-year period. So we could probably see another year of strong prices across that soft sector. The agricultural sector is always going to be the fastest response, the shortest cycle.
And so you are seeing pressure in terms of soybeans, corn, wheat. So those will probably be a drag for another year. And in terms of if we're thinking about high level commodities macro, the kind of world we're headed in, I think we're continuing to move in a direction where trade is less free.
And I think in the end, what that means is supply chains need to reshuffle, readjust. You're going to lose economies of scale. You're going to get parallel supply chains. And I that's a world which is very, very good for commodities.
INGRID: So I heard near-term constructive on metals, near-term construction on energy and oil, and near-term constructive on soft.
HUMZA: Yes.
HUSSEIN: I'm worried that-- so we've reduced our risk.
INGRID: That's my next question. What are you worried about?
HUSSEIN: Yeah. So to be very clear, we have reduced our risk in metals because we do think that there will be noise there as Trump takes office. And if his prior presidency provides any playbook, it's going to be noisy. And we think metals probably come under some pressure into that window.
We like energy, but I'm not in the energy is going to $100 per barrel camp in 2025. I think it's probably a 65 to 85 or 70 to 90 commodity. There's risk, of course, if there is a material escalation in Israel, Iran. That could challenge production in a meaningful way. And we don't have inventories to meet that disruption.
And then I think on the grains, it's tactical, right? If you look under the hood, overall, we're bearish grains, but we're overweight. We're long corn, relative to benchmark. We're short soybeans. We're long soybean oil. So there's a lot of nuances.
Going back to your earlier question, there are folks who can do this on their own. Humza, Tim, and myself, we spend 10, 12 hours a day looking at these fundamental balances and trying to identify the commodities that we think are going to outperform, get long those guys, and try to get short the guys that are going to underperform.
INGRID: Gentlemen, thank you so much. It's been a great conversation. And to our listeners, we hope you've enjoyed it. You can always find more information on our website at tdassetmanagement.com. And of course, you can listen to our podcasts on your favorite streaming services-- Apple, Spotify, Amazon. Thanks, and have a great day.
[MUSIC PLAYING]
HUMZA: Thank you very much.
HUSSEIN: Thanks for having us.
NARRATOR: The information contained herein is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax, or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual's objectives and risk tolerance.
This material is not an offer to any person in any jurisdiction where unlawful or unauthorized. These materials have not been reviewed by and are not registered with any securities or other regulatory authority in jurisdictions where we operate. Any general discussion or opinions contained within these materials regarding securities or market conditions represents our view or the view of the source cited.
Unless otherwise indicated, such view is of the date noted and is subject to change. Information about the portfolio holdings, asset allocation, or diversification is historical and is subject to change. This document may contain Forward Looking-Statements, or FLS.
FLS reflect current expectations and projections about future events and/or outcomes based on data currently available. Such expectations and projections may be incorrect in the future, as events which were not anticipated or considered in their formulation may occur and lead to results that differ materially from those expressed or implied.
FLS are not guarantees of future performance, and reliance on FLS should be avoided. TD Global Investment Solutions represents TD Asset Management Incorporated and Epoch Investment Partners Incorporated. Both entities are affiliates and wholly owned subsidiaries of the Toronto-Dominion Bank.
Canada
