What Does the U.S. Manufacturing Recovery Mean for Commodities?

Given the unfortunate second wave of the COVID-19 pandemic, it’s easy to focus solely on what the negative impact could mean for the U.S. economy. However, somewhat lost in the shuffle of data headlines is one sector of the U.S. economy that has been able to actually outperform expectations: manufacturing. 

The monthly release of the ISM Manufacturing PMI report is a closely watched factory gauge. For this index, a reading above 50 is viewed as an indication that the economy is in expansion territory, while a level below this threshold indicates contraction. After plummeting to its lowest level since the financial crisis/great recession in April, the PMI reading has visibly been on an ascending trajectory, and in December hit its highest level since early 2018.

So, what’s behind the resurgence, you ask? With consumers unable to spend on leisure items, such as dining out, vacations, etc., household spending has apparently shifted gears towards expenditures that are more stay-at-home-centric, like appliances, household renovations/improvements and automobile sales. With many of the nation’s factories shut down during the first wave of the pandemic, a trickle-down effect occurred whereby production of industrial commodities fell, inventories declined and vendors/suppliers became overly cautious of the outlook.

A January 24, 2021, Wall Street Journal article, “Manufacturing Rebound Has Suppliers Struggling to Keep Up,” highlighted these developments. Perhaps even more notable, what this renewed factory activity has meant for commodities prices is that the prices for aluminum, copper, steel scrap and lumber have all gone up. In fact, in the January 2021 ISM report, the price component rose to its highest level since April 2011, with all 18 industries in the survey reporting paying higher raw material prices.

It doesn’t end there though. The article mentions how “some manufacturers have stockpiled materials to guard against a lack of availability in the future.” Although Federal Reserve (Fed) Chair Powell stated at the January FOMC meeting that any upcoming increase in inflation should be viewed as “transient”, if the law of supply and demand is any guide, could we be witnessing the long-awaited first stages of inflation after all? Perhaps more importantly, how can investors position their portfolios for this possibility?  

GCC

WisdomTree recently re-positioned the WisdomTree Enhanced Commodity Strategy Fund (GCC) into a ’40 Act investment fund with no K-1 that provides broad exposure to a diversified basket of commodities.

We emphasize the diversified nature of this commodity basket compared to the traditional well-established commodity indexes like the S&P GSCI Index (SPGSCI), which could have as much as 70%–80% of risk driven by exposure to the energy sector. We didn’t want an energy-driven commodity fund, and attempted to maximize diversification within various commodity weightings.  

The strategic weights of the major commodity groups are roughly risk balanced between precious metals, industrial metals, agriculture and energy, and that risk-balanced nature brings an over-weight to precious metals and industrial metals, and under-weights to energy.  

Our strategic industrial metals over-weights are well-positioned for the manufacturing and factory growth described above. But in addition to the cyclical impulse from strong growth, our team views the growth in battery technologies as being a long-term driving force for metals like copper and nickel. Supply is constrained and demand is accelerating. 

Our team views inflation as one of the major themes of 2021– and we believe GCC’s broad-based exposure to commodities provides a good solution to hedge that inflation risk.