Commodities outlook: what to check before buying funds and ETFs

Commodities tend to behave differently from conventional asset classes (shares and bonds), which means they can be very useful for the purposes of diversification and as an inflation hedge.

For some investors, the desire for diversification may have added importance as commodities offer a differentiated way to access the energy transition and AI-related themes other than holding additional tech shares.

• Invest with ii: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Clive Burstow, senior thematic equity portfolio manager, HSBC Asset Management, notes: “Commodities and related equities can bring diversification benefits to portfolios at a time when many equity markets are increasingly driven by similar themes such as AI and data centres.” 

For other investors, commodity exposure is used for diversification instead of bond exposure.

“We see commodities through a portfolio construction perspective, in line with our role as multi-asset investors,” says Anthony Rayner, fund manager, Premier Miton Macro Thematic Funds, which maintains exposure to a wide range of commodities. “In an elevated inflation environment, such as now, commodities generally do a much better job of diversifying equity than bonds.”

As ever, balance is key. Spreading risk by owning a fund backing multiple commodities gives a portfolio more resilience. Whereas, in owning just one commodity, investors are more exposed to getting their timing right when buying and selling. It is also important to bear in mind that the price of a single commodity will fluctuate rapidly at times.

We asked a range of experts for their outlooks for both precious and industrial metals, while also highlighting routes to gain exposure to this area.

Gold and silver

In the precious metal sector, recent consolidation is likely to prove just a temporary pause as gold continues to benefit from sustained buying from central banks such as China, Poland and Kazakhstan. The World Gold Council reported that central banks bought a net 289 tonnes in Q2, up 62% year on year, while Beijing bought a net 20 tonnes in July, its largest monthly increase since 2023.

“We are in the midst of a secular gold bull market that is being driven by the twin structural drivers – debasement and de-dollarisation,” says James Luke, a gold and commodities portfolio manager at Schroders. “Fiscal deterioration, particularly in the US, and the assumption that central banks will ultimately turn to money printing at pivotal moments when debt and deficits threaten economic and financial stability drives the ‘debasement trade’. While geopolitical developments and the transition from a US-led unipolar world to a more fragmented, multipolar system is increasing the bias towards a neutral reserve asset and driving the ‘de-dollarisation’ trade.”

Gold equity valuations remain very low relative to bullion and producer margins are exceptionally strong, at more than double the peak reached in 2020. Most companies are in a net cash position with strong capital returns across the sector. “The downside risks are very different to previous cycles,” says Luke. “Even a fall lower in gold would leave many producers still generating meaningful free cash flow given the margin cushion.”

• Jupiter Gold & Silver interview: what drives the gold price next
• Ian Cowie: two trusts finding tailwinds amid geopolitical tensions
• Portfolio Dilemma: we tackle six investment problems

Silver may have greater potential as it has special properties. “Both monetary metals should benefit as market participants come to expect a more accommodative Federal Reserve,” says Chris Mahoney, investment manager, of Jupiter Gold & Silver I GBP Acc (BYVJRH9). “(But) silver has an additional structural tailwind. Its unique properties, including greater electrical conductivity than any other metal, make it critical to the global economy and essential to the vast amount of AI and data centre-related infrastructure that is planned. If the construction of AI and data centre-related infrastructure comes anywhere close to forecast, it is likely to exacerbate that deficit and add further upward price pressure.”

For both professional and retail investors, the demand drivers for industrial metals appear much more calculable and easy to assess than for precious metals where a plethora of macro-economic uncertainties are at play. 

Industrial metals

Industrial metals offer growth, albeit with a bumpy ride, whereas gold and silver are perhaps more speculative.

A decade ago, industrial metals such as copper and lithium were seen as an homogeneous group of simple raw materials, but a new paradigm views these metals as vital strategic assets that are increasingly discussed by governments in the context of technological leadership and national security.

Demand has increased sharply while mining supply cannot keep pace. The world now consumes roughly 2.8 billion tonnes of metals annually, the equivalent of building 750 Eiffel Towers every day. Demand for copper alone has surged to roughly 28 million metric tons annually and is projected to rise to 42 million metric tons by 2040.

“Among industrial metals, copper offers one of the clearest examples of structural demand running up against constrained supply,” says Steve Land, portfolio manager at Franklin Equity. “Electrification and traditional infrastructure investment are increasingly being joined by growing demand from power networks, data centres, and AI-related infrastructure. At the same time, ageing ore bodies, long development timelines and the challenges of bringing major projects online continue to constrain supply growth.”

Bringing a large mine from discovery to full production typically takes about 15 years. “The process involves far more than geology: years of exploration, permitting and environmental approval, securing social licence from local communities, navigating political and regulatory systems, arranging financing, and finally building complex infrastructure,” says James Budden, global head of marketing at Baillie Gifford. “The result is a thin project pipeline and a market more vulnerable to disruption than for many years.”

• Jupiter Gold & Silver interview: the big opportunities for gold and silver investors
• HALO stocks: AI-immune areas the pros are backing
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Lithium’s demand has traditionally been heavily tied to the electronics and automotive sectors, but the role of lithium batteries in balancing grid-scale storage is taking it beyond a single-theme story. Prices have risen sharply since last year, exceeding $18.00–$25.00/kg for battery-grade lithium carbonate in May, before correcting to $14.10–$17.60/kg in August.

From an investor’s perspective, the risk profiles of these two metals  – once so radically different – are converging, but copper is still seen as the less volatile despite its sensitivity to Chinese industrial demand and it is the highest-conviction commodity held by fund managers by some margin.

Lithium is also viewed as an attractive opportunity, but some fund managers have concerns such as the risk that sodium-ion batteries will dilute demand.

“Lithium is a good example of where we take a differentiated approach,” says Ben Shrewsbury, an investment manager at Aberdeen for global natural resources and emerging market equities. “While the long-term electrification story remains intact, the lithium market has demonstrated how difficult commodity forecasting can be when supply responds aggressively. Significant uncertainty remains around the pace of electric vehicle adoption, future battery chemistry and the durability of pricing. While we have exposure to lithium producers, we generally prefer to access the battery value chain through industry leaders such as CATL (Contemporary Amperex Technology Co Ltd Ordinary Shares - Class H (SEHK:3750)), where we can benefit from battery growth while reducing the commodity price risk inherent in upstream producers.” 

The ‘how’

Exchange-traded products (ETPs) offer a cost-effective and liquid way to gain exposure without the burden of physical storage.

Equity-based commodity exchange-traded funds (ETFs) invest in shares of commodity companies by tracking an index. Whereas exchange-traded commodities (ETCs) are instruments that track the price of the commodity, or a basket of commodities. They can either be physically backed by holdings of the commodity itself, or may use so-called swaps with other financial institutions to provide the exposure. ETCs also allow investors to “short” or “leverage” their investment, allowing investors to take bets on the price either falling or rising. Investors should be careful here, as although there are potential gains to be made, there could be huge losses too.

The most-popular choices among interactive investor customers in the second quarter were iShares Physical Gold ETC GBP (LSE:SGLN),iShares Physical Silver ETC GBP (LSE:SSLN) and Global X Silver Miners ETF USD Acc GBP (LSE:SILG). 

However, there are some drawbacks to going down the passive route, which Oliver Hextall, a commodities fund manager at Fidelity, points out.

Hextall says: “Many critical materials, including lithium, uranium, cobalt and rare earths, have immature or illiquid futures markets, limiting the ability of exchange-traded commodities to provide scalable exposure. Meanwhile, broad commodity indices remain heavily weighted towards legacy commodities and can therefore dilute exposure to structural growth themes like electrification, digitalisation, and resource security.

“This matters because this is unlikely to be a cycle in which all commodities or companies benefit equally: changing technologies, geopolitics, cost curves and supply-chain positioning are creating increasingly differentiated winners and losers.”

• Funds dominating the commodity complex
• Fund Focus: the minnow investment trusts to back

The opposite line of thinking, of course, is that “broad commodity strategies provide access across sectors and help investors participate in inflationary environments that may be driven by different parts of the market at different times”, according to Marc Khalamayzer, senior portfolio manager at Columbia Threadneedle Investments.

Both approaches are valid: it depends on the investor’s risk appetite.

What is clear is that the best commodity-related and mining companies typically deliver superior returns over the long term than physical commodities, but their fortunes are driven by business-specific factors, such as in-ground reserves, production growth, operational leverage, and shareholder distributions, which are difficult for outsiders to assess.

“Understanding the quality of a resource, the economics of a project and the ability of management teams to deliver can make a significant difference,” says Mark Smith of WS Amati Strategic Metals B Acc (BMD8NV6) fund. “Regular engagement with companies, site visits and financial and technical expertise provide insights that go beyond headline market data.”

It follows that unless you are looking at established and well-researched companies, it is prudent to outsource the decision making.  

The commodities and natural resources investment trust sector seems a good starting point and features a small, highly specialised selection of funds of which BlackRock World Mining Trust Ord (LSE:BRWM) commands around half of the assets of the entire group.

As Tom Holl, co-manager of BlackRock Energy and Resources Income (LSE:BERI), points out: “The investment trust structure allows us to invest in less liquid opportunities without being constrained by investor flows.”