TDAM Talks Podcast: Commodities - From Cacao to Crude

HUSSEIN: People need to understand that, you know, commodities are not some faraway thing in a faraway place that impacts all of us. And if you believe in economic growth and I think this is really important, if you believe in economic growth, you need commodities to facilitate that economic growth. And as you see that economic growth, commodity demand benefits.

INGRID: We are recording this podcast in May on the eve of Mother's Day. And as a mom of four grown and out kids, I'm typically just grateful for my time with them. But I'm a woman and genetically predisposed to a love of chocolate jewelry. So how fitting that today is. That's what we're going to be talking about.

Well, not exactly, but cacao and precious metals are just going to be part of our overall commodities narrative. Those two among many have been on a bit of a tear of late. So we are going to be spending the next 20 minutes or so talking about commodities, where the opportunities are, how investors can access the market. Historically, this market's really only been available primarily to sophisticated and institutional investors. But we're going to talk about how everybody can access the market today. So. Hello, everyone. My name is Ingrid MacIntosh, and on the podcast today, I have the pleasure of welcoming Hussain Altadena, managing director and head of Commodity Investing here at TD Asset Management and introducing Roxane La Pena, a member of TD Asset Management's Asset Allocation Team, which manages solutions totaling more than $1 billion for our individual and institutional clients. The three of us are going to have this amazing chat promise. It's going to be amazing guys on both how we capture value in the commodities landscape and the role commodities can play in both. Adding return and reducing risk in investors portfolio. And as always, I am going to be grilling them on a few topics that have come up within our advisor community in my rapid fire session and they don't know the questions yet, so make sure you stick around for that. Husain, Roxane, welcome.

ROXANE: Thanks for having us.

HUSSEIN: Thanks for having me back.

INGRID: You're saying you were going to make a shout out to your mom here since it's Mother's Day weekend?

HUSSEIN: Well, she'll probably be the first one that listens to this podcast when it's published. So happy Mother's Day, Mom. Love you.

INGRID: There you go. And both of my kids are listening, so maybe they'll remind them if if they haven't come through for me that we're going to be there. Okay. So, Hussain, you have been in the commodities markets for over 20 years, both north and south of the border and prior to joining us, you worked at one of Canada's largest pension funds. You've been with us for about three years, building out, I believe, one of the first and only dedicated in-house commodity teams in an asset management company in Canada. How's it going? What have we accomplished? What's going.

HUSSEIN: On? It's been great. So, yeah, I joined in March of 2021. When I joined, we didn't have the ability or optionality to invest in commodities. We started investing in commodities and some of the solutions that Roxane and her team manage. Over a year ago and last September, we launched a dedicated commodities pool, the true alternative commodity pools, so individuals can get that commodity exposure in their portfolios is wonderful.

INGRID: Roxane, first timer on the show. Welcome. Tell us a bit about team. Tell us about how we're thinking about commodities and, you know, I think I've sort of got both sides of it here. I've got the, the manager of the ingredients and the designer of the recipes. Here is to talk a little bit about that.

ROXANE: All right. Well, first of all, happy to be here. Thanks for having me. Yes, I work with the client portfolio management team covering asset allocation. And basically I sit with the lovely portfolio managers like Hussain here, really getting into the weeds of what they're doing on a day to day basis within all of the funds in asset allocation. And the ultimate goal is for me to take that information and use it to address clients needs. So what that really means is making sure our clients understand what we're doing in our portfolios, how they should be thinking about allocating to them, and what the role of those investment funds are in individual portfolios. So really putting all of those pieces together and ultimately helping our end clients on their journey of meeting their goals.

INGRID: Yeah, I think that's really important. Call it, because not all investing is a straight line up and how high and how fast can you get there. But it really is meeting people on every step of their journey. And commodities are a unique tool in being able to manage that. So we're going to dive a bit deeper into that. So let's start off with you Can Stay. And I kicked off the conversation with two of my favorite things like chocolate and gold. Let's go a little deeper on, on chocolate or cacao first. I think, you know, that market's been on a bit of a tear in 2024. Can you talk about this? And maybe that's going to explain to me why maybe my Mother's Day might be a little bit lean this year.

HUSSEIN: So, yes, it's cacao has definitely been making headlines over the course of the last couple of months. cacao is produced primarily in West Africa. Cacao prices prior to kind of the runup that we've seen of late. You know, if you look at cacao prices over the course of the last 20 years, they've averaged somewhere between 1003 thousand a metric ton. We've seen prices trade as high as 12,000 a ton. So it's been a pretty parabolic move over the course of the last couple of months. And I think it's a great case study in what happens to commodities that are supply inelastic. So you've had, you know, relatively weak cacao prices until this year that has resulted in the farmer in West Africa, frankly neglecting the crop, not intentionally, just not having the ability to to take care of it, to, you know, to treat it, to ensure that you're getting adequate amounts of fertilizer, etc.. And of course, we've had drought and disease in the region and that's totally, you know, challenged their ability to produce, which is now forcing the market to find a price that will ration demand where the Hershey's, the Cadbury's of the world will cut back on their on their cacao demand because cacao supply is inelastic. So even at today's higher price, if the farmer decides to go and plant incremental cacao trees, it's going to take 3 to 5 years before you get the yield. You don't you don't get cacao flour for 3 to 5 years. So the market is really trying to figure out how to limit and ration demand. We saw the same thing happen in oil in the 1970s around the Arab oil embargo. We've seen it happen in electricity and natural gas around Putin's invasion of Russia in 2022. So it's like classic commodity supply and demand and you're trying to find a level where you actually, you know, prevent your kids from buying you chocolate.

INGRID: So now I'll understand why it played out the way that it did. I as I'm listening to you, I'm thinking through for every commodity the level of research, the level of foresight, the way you have to actually think about each commodity differently to find those opportunities. And I know we're going to get into this a little bit further, but you know, creating a pool or creating a fund of commodities isn't just about that price direction. We'll talk a little bit more about some of the options markets, etc.. When people think about commodity years, they often first think about precious metals, predominantly gold. We talk about that. You know, gold has had some highs recently. I know I've got a bit of a favor for it, but can those gains continue? What's going on? What's the outlook? And maybe talk to us about why gold's out these new highs and think about how we put them in portfolios.

HUSSEIN: Maybe I can take the first part and talk about why gold has done what it's done. If we look at gold historically, most folks will try to use the US dollar and real rates to sort of build their gold price model. Both the US dollar and real rates have moved in directions over the course of the last 12, 16, 24 months that arguably should be gold negative real rates have increased, which increases the opportunity cost of holding gold and the dollar has has, has strengthened as well, which is typically bad for dollar based commodities. Notwithstanding that, we've seen gold prices move to nominal record highs, 2320 400 an ounce. And I think this is entirely a reflection of robust central bank buying and particularly M central banks. So if you look at flows into China, into Russia, into Turkey and into other EM central banks, you're seeing a growing need for diversification even on their part. If you look at M Central bank reserves, they hold a ton of fiat currency. You contrast that to the diem that is more balanced, more portfolio diversified. I think you're seeing appetite partially because of concern around the value of fear. If you ask me, Ingrid, what's my view on gold over the course of the next couple of weeks? I have I have no idea what gold does over the course of the next couple of weeks, couple of months. But I do think structurally it continues to improve. And I think those factors which have potentially acted as a bit of a headwind, the strength in the dollar and real rates, I think both those things are probably going to be weaker 12, 16 months from now than where they are today. So tactically, that should help. Gold structurally, I think you want to have in your portfolio and I think Roxane can talk a little bit about why.

INGRID: So irrespective of whether it stays where it is, retreats or goes higher.

ROXANE: Yeah, I mean, there's definitely always a place in the portfolio for, for precious metals. But I think, Ingrid, when you first brought this up, you mentioned how you put this into the precious metals category. And of course, whenever people think about precious metals, they do certainly think about our allocation. Overall, the precious metals is about 20%, but 15% of that is gold. 5% of that would be about it would be in silver. So if you can kind of just walk through all of the drivers of what's causing gold price to move and what our view points are there. But silver actually has a very different component. There's an industrial component to silver, and I think people often forget about that. So it's very common to think about what the role of gold is in a portfolio. You know, you get that inflation hedge, you get that tail risk has what you think about geopolitical concerns, but diversifying that precious metals basket with silver gives you that additional, you know, exposure to the industrial component. So what does that mean when you think about the underlying drivers of commodity returns? Well, now you're thinking a little bit more about economic growth and kind of the fundamental drivers of economic growth from that perspective and how you really do need these commodities when it comes to creating a well-functioning economy and watching that grow. So again, going back to that point of focusing on the allocation of precious metals, while holistically we have a diversified basket of commodities and each of the underlying commodities really does have a unique driver of returns. Fundamentally.

INGRID: Is there an expansion question on that? You know, let's go further down the industrial metals category, like how do we think about that?

HUSSEIN: I think if I back up a little bit and listen to what Roxane said and I agree entirely with what she's saying, the allocation or the addition of commodities into your portfolio, the addition of a diversified commodity basket into your portfolio improves that overall portfolio because of the low correlation, because of the diversification, the metals play a role in that, right? Energy plays a role. Energy plays a very meaningful inflation hedging role. Metals, silver included, are highly correlated to economic activity. And you know, we've talked about this before and I'm sure we'll talk about it again, but the metal space in particular has seen a dearth of investment, and metals in particular have a very long lead time. So we said cacao takes 3 to 5 years before you can, you know, see the cacao pods developing. If I'm trying to go and find incremental copper, greenfield copper, I'm talking about ten, 12 years. That's on the supply side. On the demand side, you know, our move away from sort of conventional energy to renewable energy, the increase in in power generation demand, broadly speaking, is extremely constructive for copper and aluminum demand because that's how you conduct the electricity that we're going to need to power our cars and our what have you.

INGRID: That's the perfect lead into my next question, which is going to be in the category of oil, right? So what about oil? What about that tightening supply from OPEC? What does it look like in terms of the price now and in the future? And what are kind of the drivers around that? Because there is a ton of stuff going on in the world right now.

HUSSEIN: Yeah. So, look, I think we've had the view that oil likely trades in a range 70 to $90 a barrel. The starting point is that inventories are extremely tight and that is a symptom of, you know, the stuff that I've talked about for a while. It's a symptom of the fact that we've not invested in the supply side, but in particular over the course of the last two or three years from the lows of COVID, we've seen a material contraction in inventories, including the drawdown in the Strategic Petroleum Reserve in the U.S. The reason we don't think, well, you know, necessarily breaks through 90 in in the current year is because OPEC does hold somewhere between four and 6 million barrels a day of spare capacity. They have frankly engineered the tightness that we're seeing in the market and created that backwardation that we're seeing. If we were to see, you know, demand surprise to the upside or if we were to see a supply side disruption, depending on geographically where that disruption took place, OPEC could likely meet that incremental demand or supply disruptions. So that's why we're not in the camp that oil trades triple digits this year. Again, I caveat that, Ingrid, if we do see an unfortunate geopolitical event that challenges, for example, supply in the Straits of Hormuz, then that OPEC's spare capacity becomes a little less meaningful. But ignoring that sort of scenario, supply and demand looks like it's going to continue to tighten, at least over the course of the second and third quarter of this year. OPEC seems to be keen on keeping sort of their volumes relatively constrained. And on the demand side, things are looking good. If we look at high frequency demand data, it's actually registering probably in the 1.4, 1.5 million barrel per day range, which is higher than most people thought in Q1, Q2 of this year.

INGRID: When do we start to see that green transition and the move to EV vehicles actually start to impact the price of oil?

HUSSEIN: So I'm totally out of consensus here, right? I'm not in the camp that oil demand is going to peak in the next three, five, ten years. We are seeing for sure a uptick in the number of, for example, EBI cars that are on the road. We're seeing an increase in, you know, solar generation when generation which is limiting, you know, your conventional energy demand in the power stack. But we have to remember that with economic growth comes commodity demand growth and particularly energy demand growth. You can't get around the reality. We haven't figured out how to get around the reality here, where you need power, you need energy to drive growth. And as growth increases, my income increases. And if it's increasing from a low level, I'm likely going to consume more food, fuel, fertilizer. And that that process is greater than what I'm losing in the oil balance or the dirty energy balance to the renewables.

INGRID: So the ultimate sources of energy are helping us keep up with the demand effectively. Right. But they're not is it is in the way people.

HUSSEIN: Are demand growth on the margin. I'll argue that it's not limiting it. It's it's not limiting it sufficiently to lend to surplus balances in the oil market. I think it's actually the opposite. And coal gives us that example, right? Years ago we said coal is dirty, we should stop producing it. We stopped consuming it, but the production side fell far quicker than the demand side. And that's what's happening I think in the in the energy space.

ROXANE: And I think with that, you know, we talk a lot about how we're obviously seeing these increasing prices in oil, seeing the supply and about supply demand imbalance when it comes to energy in general. But I think from an investors perspective, we always have to think about, well, how do we actually profit from this? And I think in general, people tend to think that, oh, well, I already have an energy exposure because I'm allocating to the TSX in my portfolio. I bought Suncor the other day, so I'm good. I've got a direct exposure to oil prices and I think this is where, you know, we kind of jump in with our close offering and want to really explain that there's direct exposure and there's indirect exposure to underlying commodities. Direct exposure is through the derivatives market, and that's exactly what we're doing here with U.S. expertise. So when it comes to derivatives, you have to think about the fact that the market participants are very different. These aren't just stocks being traded on the stock market. Our counterparties are consumers. They're producers of, you know, the underlying commodity. And when you mentioned backwardation, I don't know if anyone caught that earlier. This is a pause.

INGRID: I was hoping you would go there. Yep. Nobody go there.

ROXANE: Yeah, I think a lot of people don't quite understand backwardation means, which is very it's not a word that's used commonly. It's specific to the derivatives market and the shape of the curve for those contracts. So because oil is in backwardation, we're able to get a positive role yield from that. What does that mean? Well, Hussein mentioned that we have low inventories. So when you think about consumers, producers, they're happy to pay up to make sure that they have that available for them. Right now, we're on the other side of these transactions. You know, we're happy to buy these contracts farther out the curve and we have to roll them up because I think Hussein will attest to this. We don't want to start holding a bunch of barrels of oil in our offices on on Bay Street. And because of that, you have to get Sicily rolled as and we get about a 10% roll yield right now when it comes to oil specifically. So when you're thinking about how you can profit or benefit from commodities exposure, it's not just that price appreciation that we do foresee coming, but it's also the fact that you get that positive roll yield when the curve is in backwardation and there's also collateral yield. So it's kind of like three legs to a stool or think about it as stacking returns, price return plus real return plus collateral yield just because of the nature of the derivatives market.

INGRID: That was that was a a lot and exactly where I wanted you to go. Right. Because I think, you know, I just I just did a podcast with Collin Lynch, who's our head of alternatives here at TDC. Benjamin, of course. And we've been talking about this democratization of asset classes that historically were not available to the individual investor. And clearly what you've laid out is a very complex process that not anybody can just go out and do. Now we actually have a way to pull this together and create it in a consumable way for individual investors. So let's sort of talk a little bit further about the like, how do we think about putting them in a managed solution? Roxane, How do we think about and hold on, you know, he's saying at the beginning he said we started allocating first directly into commodities and then we've created vehicles so we can add. So maybe we'll start on the sort of the direct piece and then how we put it into the solutions.

HUSSEIN: Yeah. So I when I joined in March 21, Michael Craig, who runs asset allocation, I think his motivation for bringing the the sort of return stream to team was to build better portfolios for their clients. So we started, you know, a year into my time here investing in commodities in some of the managed solutions that Mike manages and then we took that. And again, what we were doing in his solution is not dissimilar from what I was doing at the pension plan. We took that solution, built it into this standalone T alternative commodity pool, and I'm sure Roxane can talk about how we're using that in other solutions. Now, today.

INGRID: Yeah, an advisor, an individual can't replicate what we're doing.

ROXANE: Exactly.

INGRID: In creating the pool. So traditionally when people think about investing, they've typically had access to public markets which are becoming increasingly efficient. It's harder to add value in the public markets. So when we talk about alternatives, democratization and now commodities, having access, it is another asset class, it is another source of return, but also a source of diversification we witnessed in 22, you know, this real moment of correlation where both fixed income markets and equity markets were really, really challenged as we reset interest rates effectively and had the headwinds in the equity markets, how might commodities have helped in a market like that?

ROXANE: I think can help for, for multiple different reasons. I mean, so first of all, if we look at 2022, as you mentioned, correlations went to one. So the pain was really felt widespread through every single type of investor, while commodities are actually up double digits that year. So having that exposure in your portfolio would have helped cushion on the downside sort of that that pain that clients felt. And if you think about who was feeling the most pain during that time, it was conservative investors.

INGRID: The retirees, the accumulators, etc..

ROXANE: Right, exactly. And I think we always talk about, you know, when you're trying to help clients along their journey, you want to make sure that they're not experiencing these meaningful drawdowns, especially when they're withdrawing capital. So during periods of time like that, having additional cushion where our clients don't have to specifically withdraw capital in a down market is quite beneficial over the long term.

INGRID: Yeah, and we talked about this at the outset. Not all all investors are created equal because while you're on that investing journey and building your nest egg, you don't mind the market volatility if you don't meet the money. But once you are in that drawdown stage and a retiree stages having that lower volatility to your point, not having to withdraw from a depleted portfolio and not when you can't get that return back or can't get that money back. What do we wish Investors generally knew more about commodities.

HUSSEIN: So for me, sure.

INGRID: I know Brock. That'll have an idea too. But what do we wish people knew more about?

HUSSEIN: How long do we have now? Look, I.

INGRID: Can do another podcast on this.

HUSSEIN: No, I look, I think I think the one piece that we've forgotten because of kind of how we've evolved over the course of the last 1500 years, we consume a lot of things, but we don't think about the commodities that are used in that consumption. So like my Apple iPhone right? My, my kid wants an iPhone, he buys an iPhone, he's got an iPod. He doesn't he he has no idea what's in that iPhone or how that iPhones made. Right. The critical materials, the base metals that are in that iPhone, the energy, the commodity used to get that iPhone from wherever it was produced to his hands. So I think people really need to appreciate and think about how integral commodities are in their sort of day to day. It's not something that, you know, is going away, I…

INGRID: Think esoteric, you know, an additional.

HUSSEIN: Like you've touched it so many times today and you hadn't even thought about it that you benefited at so many from it so many times today and you haven't even thought about it. It goes.

INGRID: Chocolate. I did have a chocolate croissant this morning, but.

HUSSEIN: But ultimately you had a coffee. Yeah, right. And it and you know, you got to work and there were commodities involved in that. And we're sitting at a desk here and there's commodities involved. And I just people need to understand that, you know, commodities are not some faraway thing in a faraway place that impacts all of us. And if you believe in economic growth and I think this is really important, if you believe in economic growth, you need commodities to facilitate that economic growth. And as you see that economic growth, commodity demand benefits.

INGRID: Felt like a mike drop moment. Roxane, what would you add?

ROXANE: And if you find you know, we talk about how prices are going up across the board as humans in general, as investors in general, we feel inflation constantly on a day to day, from a day to day perspective, you know, we can pivot our spending accordingly to maybe lower our cost of living to a certain extent. But I think it's important to think about, well, how am I pivoting my investment portfolios to also protect me from those same things?

INGRID: It's a great way to think about it. So let's look forward to what are the other themes in the commodity space? What are we looking forward to in the back end of the year? We've talked touch on a bunch of things, but are there any themes I've missed?

HUSSEIN: So when we talk about commodities, we always talk about geopolitics, so I won't do that. That's always a theme. I think kind of the three kind of big things to think about, not necessarily just into the end of this year, but over the course of the next decade. ESG and energy transition that has material impacts on commodities. If you're thinking about commodities like oil, coal, natural gas, ESG is likely to limit investment, all else equal in those commodities. ESG and energy transition will benefit on the other side, the metals in a very meaningful way because your EV battery has materially more commodity in it, your EBY car has materially more commodity in it. You'll also need when you think about power generation, you know, a lot of talk about AI in video, etc., the amount of power that's needed to drive those data centers is meaningful. So that's going to have an impact on first the upstream, what's going to be the source of that power generation. But again, going back to the metals, you're going to need a lot of copper and aluminum to move this power around. And then I think the last thing that we need to think about and we've touched on a little bit already, is more of these sort of, you know, macro portfolio construction. You alluded to the fact that, you know, equity fixed income correlation may not be what it has been or what we've become accustomed to over the course of the last two decades. Going forward, I really need to spend more time thinking about how I build my portfolio in that environment. And I think commodities are increasingly in that conversation.

INGRID: Thankfully, saying, okay, so we've been at this for a while. I promised our listeners I was going to hit you guys with a surprise Rapid Fire round. I'm going to throw three unique words to you don't have to answer in one word. So what's coming for you?

HUSSEIN: Hussain Uranium integral into the AI, into our ability to generate the power that we're going to need going forward. Corn The band or the commodity? The commodity supplies look relatively comfortable. The harvest in South America has has done reasonably well. Farmers in the U.S. and North America are planting and conditions look good. So where we're actually bearish corn and underweight in our in our fund right now.

INGRID: Copper.

HUSSEIN: Energy transition with it's not at all going to be possible without copper.

INGRID: Copper more copper and more copper obviously that's positive. Okay. We've been at this quite a while. I think we could do another whole hour on this the way we hope would be, but can be for another session. Thank you so much for joining us today.

HUSSEIN: Thank you for having us. And happy Mother's.

INGRID: Day and happy Mother's Day. You saved Mother's Day. There you go. On a parting note, I just want to say huge congratulations to everyone that helped us put together the TEDMED Talks podcast. I know I've been doing this for four years now. We recently passed the six month mark of publishing our podcasts on preferred platforms. So Spotify, Apple, Google and Amazon. And we are absolutely thrilled with the response from you, our listeners. So thank you. Please share this podcast with a friend, a colleague, like Follow. Let us know Les comment. Tell us what you'd love to hear more about. Thanks so much everyone, and have a great day. And for those listening, I'll be had a happy Mother's Day.