Despite the persistent low interest rates environment that we have been in since 2009, the threat of inflation only surfaced in 2021 with the surge in commodity prices in the past one year and inflation fears being amplified in the media in the last few months.
Some may argue that the great commodity run happened because the prices came off from a low base due to Covid 2020 and that the economy has recovered significantly since then. The Federal Reserve acknowledged the inflation threat but has dismissed it as a transitory issue and opined that the supply was disrupted by the pandemic.
I only agree in part because some commodity prices have hit 10-year highs and that would be beyond the impact of Covid alone. It could be a case in which one of the consequences of prolonged cheap money is finally showing up.
Copper made a 10-year high at a price of $4.766 per lbs on 3 May 2021, surpassing the previous high of $4.474 per lbs on 25 Jul 2011.
Lumber made a record price of $1,686 per 1000 board feet on 3 May 2021 as well, versus the previous high of $624 in the week of 14 May 2018. (This could be largely due to Covid as Americans move to suburbs and require more lumber to build homes)
Gold reached the peak of $2,034.70 on 3 Aug 2020, surpassing the previous high of $1,883.70 in the week of 29 Aug 2011.
I am not certain if the inflation theme is going to continue but there’s no harm in hedging it with a small position.
There are several ways to trade the inflation theme and the three main approaches are via:
- Commodity Sector ETFs
- Commodity-related stocks
- Commodities
#1 – Commodity Sector ETFs
ETFs are making it easier for investors to get an exposure to a sector without the need to analyze individual stocks and decide what to pick – just buy the whole basket if the tailwind is helping the entire sector.
That is especially apt for the commodity sector currently and there are some ETFs to get you the exposure you want. (I compiled the Best Commodity ETFs here)
SPDR S&P Oil & Gas Exp & PR ETF
As the name suggests, this ETF gets you exposure in the oil and gas sector. About 66 per cent of the allocation are in exploration and production companies (upstream). Another 26 per cent are in refining activities (downstream). The remainder are vertically integrated.
Higher oil prices are good for upstream as they can sell at higher prices while maintaining the same costs. It tends to hurt the downstream players as higher oil prices means higher raw material cost for their refinery products. This ETF has a bigger proportion in upstream activities and hence is suitable for inflation hedge.
It includes familiar names such as Exxon Mobil, Chevron and ConocoPhillips.
Energy Select SPDR ETF
This is another Oil & Gas ETF, similar to what was discussed in the previous section. The key difference is in the various weightage to certain stocks. Exxon Mobil and Chevron make up about 43 per cent of the Energy Select SPDR ETF while the duo is just 5.2 per cent in the SPDR S&P Oil & Gas Exp & PR ETF.
You would prefer this ETF if you believe the bigger oil and gas companies would do better than the smaller ones and hence want a larger weightage on them.
Materials Select Sector SPDR ETF
Commodities are more than just oil and gas. We have raw materials that are needed to make other products. Materials Select Sector SPDR ETF has exposure to chemicals (68%), metals & mining (14%), containers & packaging (13%), and construction materials (5%).
The top 3 holdings are in Linde (16%), Air Products and Chemicals (7%) and Sherwin-Williams Company (7%).
VanEck Vectors Gold Miners ETF
Let’s not forget about gold. Besides buying physical gold, you can invest in the gold miners too. They should benefit from the rising gold prices since the same effort of digging the ground for the shiny metal could now be sold for more.
Don’t know which gold miners to pick? Choose them all with this ETF!
The top 3 holdings are in Newmont (15%), Barrick Gold (11%) and Franco-Nevada (8%).
#2 – Commodity-related stocks
The second way to get exposure to commodities is to buy stocks of companies that are dealing with commodities. We don’t even need to look far as we have a number of well-known commodity-related stocks listed on the SGX.
First up:
Golden Agri-Resources
Owning the largest palm oil planted area in Indonesia, Golden Agri-Resources is the second largest in the world. It is also the largest crude palm oil producer in Indonesia and ranked third globally.
Second, you can go for a more diversified food and agriculture company:
Olam International
It has three main business segments:
- Olam Global Agri (OGA) – cotton, edible oils, grains, animal feeds & protein, and rice
- Olam Food Ingredients (OFI) – cocoa, coffee, nuts, spices and dairy
- Olam International (OIL) – strategic initiatives and nurturing gestating businesses
Third, we have:
Wilmar International
They have a plethora of consumer products and animal feeds:
Wilmar generated most of its revenue from Feed and Industrial Products, with Food Products in second place.
#3 – Commodities
Last but not least you can also take the most direct route of trading the commodities themselves.
Commodities are usually traded via futures contracts which can be quite confusing to retail investors. You can now do it easily via Contracts for Difference (CFDs) where it just feels like buying and selling stocks.
No need to worry about expiry dates, backwardation or contango effects in futures trading! You just trade the spot prices.
Phillip Futures offers CFDs on the following commodities:
- Brent Crude Oil
- Cotton No. 2
- WTI Crude Oil
- Orange Juice
- Arabica Coffee
- Raw Sugar No. 11
Using CFDs to trade ETF, stocks and commodities
It is not just the CFDs on commodities, you can also trade CFDs on ETFs and stocks (mentioned above) on Phillip Futures.
I used to think CFDs are unfair in terms of their price spreads but my opinion changed after observing the tight spreads on Phillip Futures. I guess the competition is good for investors – the commission has gone to zero, spreads have been tightened and services have improved.
CFDs might be the most suitable instrument to trade the inflation theme if they are not long-term positions. Personally, I prefer to hold growth stocks long term but not commodity-related investments as they tend to move in cycles, and a bear cycle on commodities can last decades. Hence, using CFDs to express inflation-themed trades would suffice.
It would also be cheaper because there’s no commission when you trade CFDs on Phillip Futures. They just earn by the difference between the bid and ask prices. You can also just buy 1 share of CFD instead of an entire lot. For example, you would need to invest minimally $455 in 100 shares (lot size) of Wilmar as compared to just $45.50 for 1 share of CFD on Phillip Futures.
This means that you can diversify widely into various commodities cheaply – you can buy all the ETFs, stocks and commodities CFDs with less capital than if you have done it through stocks and futures. Moreover, it is also going to be much cheaper because you don’t pay commissions.
If all these sound too complicated, fret not, you can get your basics down with our Value Investing Guide.
