Page 1 of 2 When it comes to commodities, it can be tough to figure out what data you should trust—not to mention which commodity ETF is the best choice. That's why we asked Tyler Mordy, director of research at HAHN Investment, to give us his thoughts on how to approach the commodity space. Mordy, also a portfolio manager for HAHN Investment, is an expert on exchange-traded funds. Not only is he a widely recognized innovator in the design and application of actively managed ETF portfolios, he is editor of a monthly newsletter, ETFocus, and is frequently quoted by publications such as the Wall Street Journal and Smart Money. Recently, HAI Associate Editor Lara Crigger chatted with Mordy about his thoughts on commodities, including what to look for in a commodity ETF, how the press has misreported contango and whether negative correlations are gone for good. Crigger: Theoretically speaking, we all know that commodities as an asset class are supposed to have low to negative correlations to stocks and bonds. But since 2008, it hasn't really worked out that way; correlations between classes have risen. Why do you think this is, and are negative correlations gone for good? Mordy: First of all, the disclosure "past performance is not indicative of future returns" is applicable to all asset classes, not the least of which being commodities. There are these regime changes that happen in asset markets. So I think there are two things we need to recognize right now. Number one, we have a progressively connected financial system. Never have we had a crisis that has been so global in nature. Now we see monetary authorities are more aligned, cross-border capital flows are accelerating, and increasingly both geopolitical and macroeconomic factors are influencing investments. We always hear the word "globalization" and think of that in terms of industrial circulation, but today's globalization is spreading most pervasively in the financial sphere. And when we look at commodities, they have become more correlated to other asset classes, particularly in economic downturns as we saw in 2008. I think you need to take a tactical view there. The other point is that the monetary environment is different than anything we've seen in the post-war period. Right now, we effectively have a banking system that's disintermediated. That is, traditional lending facilities aren't working as they used to, so we have a decline in monetary velocity and a decline in monetary supply, even though monetary authorities are trying to stimulate it. So when you have very large industrial capacity, consumers who aren't willing to take on debt, and debt markets that aren't working normally, then that money tends to flow into other asset markets, including commodities. We call it "distortion of pricing structure," and that's a form of monetary inflation. So commodities, for the last year, have been buoyed more by monetary inflation than anything else. Crigger: Will monetary inflation be the dominant influence on commodities moving forward? What about the rise of demand from emerging markets? Mordy: We're not denying that there are other very, very positive factors, most importantly emerging demand. But again, asset markets—including commodities - can outpace their fundamentals. I think that happened, certainly in the run-up to 2008, and again right now. So you have this monetary environment that's not working as it did, and consumers who are effectively trying to get income wherever they can. I think that's the Achilles' heel of commodities right now: There's just very little income. So we see a bit of an asset shift here, and commodities unfortunately don't fit into that asset shift. Crigger: We've seen a huge influx of investment dollars into commodities in the past few years. Are you saying you don't believe that will continue? Mordy: I think it will continue, but I think we should be cautious about chasing markets that have always run up. That's the same insane logic to the mutual fund market—they sell last year's winners. So with commodity markets, you have to be extra careful, because they're not stocks, they're not longer-dated asset classes. They're effectively a contract with a finite ending period, and then you have all these additional factors like weather and growing period and seasonal tendencies. So this boom/bust dynamic will not be repealed. That's not to say that commodity prices won't, in general, be higher in the future. Generally, I think they will. But the volatility is certainly more than longer-dated traditional asset classes.
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