Commodities stand to benefit from underinvestment and the clean energy transition.
Launched in May, PIMCO Commodity Strategy Active Exchange-Traded Fund (CMDT) offers long-term investors the potential for diversification and inflation protection. We have a positive outlook for commodities based on supply constraints, the transition to a net-zero economy, and their historical correlation with inflation. In this Q&A, Michael Haigh, executive vice president and commodities and real assets economist, and Greg Sharenow, managing director and head of PIMCO’s commodity portfolio management group, explain their views.
Q: PIMCO has just launched a commodity exchange-traded fund. Why now?
A: In an uncertain inflationary environment with a more volatile economic outlook, we believe commodities offer diversification and inflation-protection potential. The recent rebound in prices confirms the importance of holding commodities, in our view.
The fund launch is consistent with PIMCO's history of innovation and market leadership in commodities. We have a long-established mutual fund franchise, and the commodity ETF is a natural extension that responds to investor needs for a beta product that embeds active management.
Q: What is your near- and long-term outlook for commodities?
A: In the near term, U.S. headline inflation looks likely to moderate, but core inflation has remained stubbornly high. Critically, commodities have tended to benefit from their extremely tight link with both inflation and inflation surprises.
We foresee a mild recession in 2023. History suggests that when spare capacity and investment is limited prior to a recession, supply constraints tend to emerge once demand growth resumes. These conditions exist today, so a long-term investor may view weakness stemming from a mild recession as an opportunity to use commodities to guard against inflation.
Over the longer term, the net-zero transitions and deglobalization could add to upside inflationary risks. Transitioning to a net-zero economy will be commodity-intensive. We expect unavoidable bottlenecks as demand outstrips supply, setting commodities on an upward trend in the coming years.
Q: What about the energy outlook?
A: In the near term, despite macroeconomic headwinds, petroleum has constructive underlying fundamentals. It is remarkable that in 2022 China experienced a demand recession for oil, yet global demand grew above trend due to growth in developed markets. We expect demand in 2023 will exceed trend growth as the Chinese economy continues to emerge from its zero-COVID policy that ended last December. As growth and travel normalize, we expect gasoline and jet fuel to be the primary beneficiaries, supporting demand despite global manufacturing- and trade-related headwinds.
On the supply side, one of the biggest structural changes stems from slowing growth in U.S. shale production, with reinvestment rates the lowest in 30 years. This ultimately strengthens OPEC’s ability to influence prices, defend against downside price risks, and capture market share. Recent actions to curtail supplies despite below-average inventories benefit investors by keeping the futures market in a state of positive carry.
Over the longer term, current levels of capital investment in energy are insufficient to meet the energy-transition challenge and global demand growth. According to the International Energy Agency and S&P, annual investment in energy must increase from $499 billion in 2022 to $640 billion in 2030, even if demand growth slows and plateaus by the end of the decade (see Figure 1).
Q: Are there opportunities in agriculture?
A: Weather is always a key determinant for agriculture. Starting conditions entering 2023 in the U.S. were bullish for prices as extreme weather caused two years of poor crops and limited inventory accumulation. While we expect crops to rebuild in 2023, good weather will be crucial for the rest of the growing season in the U.S. Climate change also appears to be having adverse effects on supplies of agricultural commodities, which is supportive of prices.
Q: How about metals?
A: Metals, the most sensitive commodity to the shorter-term industrial cycle, face a clear headwind, particularly with the Chinese construction sector lagging. Nonetheless, global inventories for some major industrial metals are at the lowest levels in decades. Longer term, the transition to a net-zero economy will likely be extremely metals-intensive. The proportion of all copper consumption devoted to green energy will grow from approximately 10% now to more than 25% of global demand by 2035, according to an April 2023 J.P. Morgan report.
As the world moves toward cleaner technologies, metals markets will be put to the test because adding supply is a lengthy and capital-intensive process.
Q: Putting it all together, why the commodity ETF?
A: No index perfectly reflects the universe of commodity investments, and considerable room remains to incorporate commodities absent in existing indices. PIMCO Commodity Strategy Active Exchange-Traded Fund (CMDT) employs a holistic, quantitatively driven strategy that seeks to capture multiple and distinct risk-premia drivers of commodity alpha that have tended to deliver above-benchmark performance over time. We believe inefficiencies in the commodity markets leave an active manager considerable room to add value by assembling a basket of commodities with attractive return properties, such as roll yield. With rising interest rates having increased the collateral return in the portfolio, we believe our index-agnostic approach provides investors a potential opportunity to hedge inflation risks and improve prospects of realizing positive returns.
DISCLOSURES
Past performance is not a guarantee or a reliable indicator of future results.
All investments contain risk and may lose value. Commodities contain heightened risk, including market, political, regulatory, and natural conditions, and may not be appropriate for all investors.
Current holdings are subject to risk. Holdings are subject to change at any time. An investment in an ETF involves risk, including the loss of principal. Investment return, price, yield, and Net Asset Value (NAV) will fluctuate with changes in market conditions. Investments may be worth more or less than the original cost when redeemed.
ETFs are subject to secondary market trading risks. Shares of an ETF will be listed for trading on an exchange, however, there can be no guarantee that an active trading market for such shares will develop or continue. There can be no guarantee that an ETF's exchange listing or ability to trade its shares will continue or remain unchanged. Shares of an ETF may trade on an exchange at prices at, above, or below their most recent NAV. The per share NAV of an ETF is calculated at the end of each business day and fluctuates with changes in the market value of the Fund’s holdings. The trading prices of an ETF's shares fluctuate continuously throughout the trading day based on market supply and demand, which may not correlate to NAV. The trading prices of an ETF's shares may differ significantly from NAV during periods of market volatility, which may, among other factors, lead to the Fund’s shares trading at a premium or discount to NAV.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
Past performance is not a guarantee or a reliable indicator of future results.
All investments contain risk and may lose value. Commodities contain heightened risk, including market, political, regulatory, and natural conditions, and may not be appropriate for all investors.
Current holdings are subject to risk. Holdings are subject to change at any time. An investment in an ETF involves risk, including the loss of principal. Investment return, price, yield, and Net Asset Value (NAV) will fluctuate with changes in market conditions. Investments may be worth more or less than the original cost when redeemed.
ETFs are subject to secondary market trading risks. Shares of an ETF will be listed for trading on an exchange, however, there can be no guarantee that an active trading market for such shares will develop or continue. There can be no guarantee that an ETF's exchange listing or ability to trade its shares will continue or remain unchanged. Shares of an ETF may trade on an exchange at prices at, above, or below their most recent NAV. The per share NAV of an ETF is calculated at the end of each business day and fluctuates with changes in the market value of the Fund’s holdings. The trading prices of an ETF's shares fluctuate continuously throughout the trading day based on market supply and demand, which may not correlate to NAV. The trading prices of an ETF's shares may differ significantly from NAV during periods of market volatility, which may, among other factors, lead to the Fund’s shares trading at a premium or discount to NAV.
A word about risk: Investing in the bond market is subject to certain risks including the risk that fixed-income securities will decline in value because of changes in interest rates; the risk that fund shares could trade at prices other than the net asset value; and the risk that the manager's investment decisions might not produce the desired results. The fund will seek exposure to commodities through commodity-linked derivatives and through the PIMCO Cayman Commodity Fund CMDT Ltd., a wholly-owned subsidiary of the Fund organized under the laws of the Cayman Islands (the “Subsidiary”). The Subsidiary is advised by PIMCO and has the same investment objective as the Fund. The Subsidiary (unlike the Fund) may invest without limitation in commodity-linked swap agreements and other commodity-linked derivative instruments. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Investing in foreign-denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management, and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political, and regulatory developments. Investing in derivatives could lose more than the amount invested. The Fund is non-diversified, which means that it may concentrate its assets on a smaller number of issuers than a diversified fund.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries, and institutional investors. Individual investors should contact their financial professionals to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2023, PIMCO.
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