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As Economy Heats Up, Will Commodities?

June 10, 2013

Thanks to the life support of $12 trillion and 515 rate cuts by the world’s central banks since March 2009, the global economy’s heart is beginning to beat again. As the market senses a robust economic recovery is underway, expectations are climbing that this growth will continue. Even the Federal Reserve has hinted that it may taper quantitative easing because of the improved economic situation. As a result, interest rates are increasing.

Europe was the lone wild card, but following Germany’s change of heart away from austerity, a positive outlook for growth, and therefore, rates, is rising in that area of the world as well.

In the chart below, you can see the close correlation between the eurozone’s positive economic surprises and bond yields. The Citi Eurozone Economic Surprise Index, which compares economic data to expectations, has improved, bouncing from a low in April. At the same time, the yield on Germany’s 10-year bond has also begun to increase.

Positive Economic Surprises in the Eurozone are Pushing Yields Higher
click to enlarge

Given this rising interest rate environment, we wondered how gold, oil, and commodities, as well as energy and materials stocks have historically performed. With a hot economy, will we see hot commodities?

We found some compelling results for resource investors.

Goldman Sachs’ historical playbook finds that “higher rates are ok for Asian equities.” Since 1990, there were 35 periods in which U.S. rates rose 50 basis points or more, and 75 percent of the time, the MSCI All Country Asia Pacific (excluding Japan) Index climbed higher, says Goldman.

The research firm plotted Asian countries as well as Australia according to their growth sensitivity compared to their U.S. rate sensitivity. You can see that the index tends to be positively impacted by rising rates in the U.S. and is relatively growth sensitive.

Across Asia, China, Korea and Taiwan—proxies for global growth—are the most positively affected by rising rates. These three countries are also the highest growth-sensitive areas of the world. That makes today’s situation of economic growth with rising rates a powerful combination for commodity investors. When economies such as China and Korea are growing, their use of commodities tends to expand as well.

Rising rates and better growth positivety affects countries that are proxies for global growth
click to enlarge

On the opposite end of the spectrum, countries such as India, Indonesia and the Philippines are negatively impacted by rising rates, as their economies are domestic driven and do not benefit from rising growth expectations in the U.S.

The Key is to Take Action Now
Don’t wait for the Fed to officially raise rates, as research shows that investors historically benefited most from materials and energy stocks by getting in before rates increased. Take a look at William O’Neil & Co.’s table below, which illustrates how critical it was to be invested in commodities before rates increased.

The firm looked at individual sectors, such as retail, technology, and utilities, along with broad indices, including the S&P 500 Index, the Dow Jones Industrial Average and the Nasdaq over four decades. It calculated the gains not only received during the period of the rate increases, but also six months prior to the initiation of rate increases.

In every instance, the energy sector performed “extremely well during these periods,” with basic materials also outperforming, says William O’Neil.

Energy and Materials Show Most Outperformance During Rate Increase Period
Percent Gain by Sector and Index
Period of
Rising Rates
Best-Performing Sector Sector Gain Best-Performing Index Index Gain
Source: William O’Neil & Co.
August 1971 to
March 1974
Materials 27% S&P 500 0%
July 1976 to
February 1980
Energy 62% Nasdaq 59%
February 1987 to
March 1989
Energy 16% Dow Jones Industrial Ave. 5%
November 1993 to
February 1995
Health Care 22% Dow Jones Industrial Ave. 8%
February 1999 to
May 2000
Energy 46% Nasdaq 45%
January 2004 to
July 2006
Energy 82% S&P 500 11%

Past performance does not guarantee future results. It is possible to lose capital invested.

A Rerun of That ‘70s Show?
Looking ahead, if the economy starts to experience runaway inflation, history shows it makes sense to hold real assets. A decade ago, Investment Advisers Stephen Leeb and Donna Leeb wrote a very informative book on how to profit from the “Turbulent Post-Technology Market Boom.” The book, Defying the Market, discussed how to protect against deflationary and inflationary scares, comparing investment ideas that were likely novel to many people in their day, including energy, food, gold, and small-cap stocks.

Will Commodity Investors See
a Rerun of That ’70s Show?
  Nominal
Annualized
Returns
Source: Defying the Market, Stephen Leeb and Donna Leeb, Leeb Investment Advisors
Gold/Silver 33.10%
Gold Stocks 28.00%
Oil 26.40%
Oil stocks 14.20%
Equity REITs 12.10%
Commodities 11.00%
Real Estate 10.10%
S&P 500 Index 8.40%
CPI 8.10%
T-Bills 6.80%
Government Bonds 3.90%

One table listed the performance of these investments during an earlier era when Americans faced high inflation—the 1970s.

In that decade, gold, silver and oil outperformed many other areas of the market. Gold stocks rose 28 percent on an annualized basis and oil companies grew 14 percent. The S&P 500 Index, on the other hand, grew 8.4 percent on a nominal basis. After factoring in sky-high inflation of 8.10 percent, gold and oil still added significant real returns. The real return of the overall stock market, on the other hand, was nearly zero.

“Stocks leveraged to growth, such as the oils and oil drillers, did splendidly. But the big-cap stocks [i.e. the general market] … were complete duds,” wrote the Leebs.

While it is still too early to tell whether investors will see “That ‘70s Show” again, one valid consideration to protect from inflationary measures is an allocation to real assets like commodities.

An investment that covers all the commodity bases is the Global Resources Fund (PSPFX), which selects commodity stocks across 10 diverse industries, including oil services, exploration and production companies, as well as precious metals stocks. We believe this approach offers investors the possibility for better growth with lower volatility. Take a closer look today.

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

The MSCI All Country Asia Pacific (excluding Japan) Index captures large and mid cap representation across 4 of 5 Developed Markets countries (excluding Japan) and 8 emerging markets countries in the Asia Pacific region. The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.

Net Asset Value
as of 04/22/2014

Global Resources Fund PSPFX $9.82 0.06 Gold and Precious Metals Fund USERX $6.59 0.08 World Precious Minerals Fund UNWPX $6.32 0.06 China Region Fund USCOX $8.05 0.02 Emerging Europe Fund EUROX $8.13 0.02 All American Equity Fund GBTFX $32.40 0.30 Holmes Macro Trends Fund MEGAX $23.74 0.34 Near-Term Tax Free Fund NEARX $2.25 No Change U.S. Government Securities Ultra-Short Bond Fund UGSDX $2.00 No Change