Why add commodities if restrictive monetary policy?

CFA Level III
#1

Hi everyone,

In the Alternative Investments book P57, it says an active commodity strategy would be to include commodities in a restrictive monetary policy environment, can someone please tell me why? thanks.

#2

lower inflation???

#3

Chicks dig commodities.

#4

This question mixes two concepts:

  1. Economics topics for asset allocation

  2. Alternative Investments

We know that during restrictive monetary policies, yield curve is either flat or declining.

Cat in the roof: Decreasing interest rates implies inflation increase.

So, as commodities is a good hedge over inflation (storage value), there it comes the recommendation.

Agree?

#5

I disagree.

Restrictive monetary policy = the aim is to lower the money supply by increasing rates, in which case the economy would contract and there would be lower inflation - not higher – so CPK123 is correct…

I just don’t see why lower inflation would mean to add commodities…

Is it because non-storable commodities are negatively correlated with inflation, meaning if inflation falls, commodity values increase?

#6

Restrictive monetary policy depresses monetary asset prices.

#7

But why would you go long commodities?

#8

Diversification first and foremost. Some are acyclical. Read my post above. There are a lot of arguments, both for and against.

#9

Agree with ext :

tight monetary policy i.e. less currency in the market or higher interest rates ----> inflation slow down

slow down inflation ----> you get non storable commodities (e.g. livestock) which have no storage costs and they move against inflation…

that’s the most reasonable answer my mind can come up with.

#10

The funny part is that there’s a contradiction, somewhere else in the readings it says that commodities decline in periods of a declining economy = as a result of weakening demand for metals…

The readings are not clear to specify which type of commodity they’re referencing…

I guess they mean to buy commodities (like gold) in restrictive monetary policy (economy slows with higher rates), which increases the commodity price of gold or other flight to safety assets.

#11

it’s an allocation (what I understand from the OP), increasing the weight of commodities in restrictive monetary policy could be a side effect of lowering the weights of other monetary classes. That’s point number one.

Point two, not all commodities are tied to economic activity.

Point three, if the tightening was unexpected, then the “non-storable” commodities would provide an additional return from the weak correlation with unexpected inflation. But I don’t buy that part.

Point four, you’re implicitly buying futures.

Counter arguments exist as well, but they may be more specific. The general idea is the above.