Commodity Selloff Continues In Early Q3: PDBC Is A Commodity ETF With No K-1

Commodity markets declined in Q2. A composite of 29 top commodities traded on the US and UK futures exchanges fell by 6.27% in Q2 but was still 8.74% higher over the first half of 2022. In early July, prices continued to decline, with losses in grains, crude oil and energy markets, metals, and most other raw material markets.

The bull market in commodities began with the early 2020 pandemic-inspired lows. An unprecedented level of liquidity via historically low interest rates and a tsunami of government stimulus lit an inflationary fuse that took commodity prices to multi-year and, in some cases, all-time highs.

The bull market stalled in Q2 2022, with price plunges in many raw material markets. Bull markets rarely move in straight lines, and corrections can be brutal. The recent price action is a reminder that selloffs can shake the confidence of even the most committed bulls.

While the short-term trends remain bearish, the economic and geopolitical landscapes remain uncertain, and prices could find bottoms over the coming weeks or months. It is impossible to pick bottoms when markets are falling as they tend to drop to levels that deft rational, logical, reasonable technical, and fundamental analysis. Meanwhile, the falling knives will eventually find bottoms. The Invesco DB Optimum Yield Diversified Commodity Strategy No K-1 ETF (NASDAQ:PDBC) follows the commodities asset class higher and lower with high exposure to the energy sector.

Energy and animal proteins moved higher in Q2

The composite of energy commodities, including crude oil, oil products, and natural gas, rose 6.77% in the second quarter. The animal protein composite, including live and feeder cattle and lean hog futures, moved 3.31% in Q2.

Meanwhile, rising interest rates and a strong U.S. dollar weighed on the remaining four sectors. Base metals, the most economically sensitive sector that includes copper, aluminum, nickel, lead, and zinc, led the way lower as it fell 27.24% over the period. Precious metals, gold, silver, platinum, and palladium declined 12.91%. Soft commodities, including sugar, coffee, cocoa, cotton, and frozen concentrated orange juice futures fell 4.12%. Finally, the grain and oilseed sector moved 3.46% to the downside.

The Q2 results turned positives into negatives in the base and precious metals sectors

In Q1 2022, all six commodity sectors moved higher. The Q2 results turned positives into negatives in the base and precious metals sectors which declined 13.06% and 5.43%, respectively, over the first half of 2022.

Meanwhile, the leader in Q2, energy, was 43.86% higher over the first half of 2022, while grains moved 14.65% higher, despite the Q2 loss. Animal proteins added to Q1 gains in Q2 and were 10.96% higher over the first six months of 2022, while the soft commodities rose only 1.46% over the period.

Commodity prices continue to slip in Q3’s early days

In early July, the dollar index exploded to a new high, reaching 107.07 on the nearby futures contract, the highest level in two decades. A strong dollar and the Fed’s determination to crush inflation with higher interest rates caused commodity prices to continue to slip in Q3’s early days.

Last week, crude oil probed below the $100 per barrel level on NYMEX and Brent futures. Copper, the bellwether commodity many market participants use for guidance above economic expansion or contraction, fell below $3.30 per pound. Grains, precious and base metals, and soft commodity prices moved lower. However, by the end of last week, prices bounced from the short-term lows. Meanwhile, many commodity prices remain below the Q2 closing levels on July 8.

A combination of rising prices and a slowing economy is another economic event beyond the Fed’s pay grade

The U.S. Fed missed the boat on inflation. Throughout much of 2021, the economists at the U.S. central bank blamed rising prices and increasing inflationary signals on “transitory” pandemic-inspired factors. They ignored inflation, and they were dead wrong. Late last year, the CPI and PPI data became more than they could handle, triggering an economic epiphany that led to the current hawkish approach to monetary policy.

The war in Ukraine threw economists a curve ball. A batter who cannot hit the curve ball will never make the Major Leagues in baseball. In economics, the Russians’ invasion of Ukraine was an unhittable curve ball, as the Fed and other central banks have no tools to address supply-side shocks. Energy and agricultural markets turned out to be a devasting Russian curve ball for the U.S. and Europe. Food and energy are Russian weapons that impact the West.

In the most recent Fed minutes, the central bank harped on inflation, mentioning the economic condition around ninety times. There was not one word on recession, a condition that would create a stagflationary environment. A combination of rising prices and a slowing economy is another economic event beyond the Fed’s pay grade. Q1 GDP contracted, and the odds are the same for Q2. Copper, a nonferrous metal highly sensitive to global economic conditions, reached a record high in March before tanking and falling below technical support in late June.

The chart shows COMEX Copper Futures (HG1:COM) fell from the March 2022 record $5.01 high to the most recent low under the $3.40 level in early July. The move below the August 2021 $3.98 low took out a critical technical support level. Copper has been screaming recessionary pressures are building. Market participants that don’t follow copper received signals from the stock market and other raw material prices. The bottom line is that markets across all asset classes have signaled that recession is not only a clear and present danger but has already begun.

Meanwhile, just as the Fed missed the inflationary signs, they are doing the same with the recessionary signals. The central bank’s economists are data junkies, but the data they employ has been stale. Eating stale food can lead to food poisoning, and monetary policy based on stale data can poison an economy. Technology has provided us with incredible real-time tools. When will the world’s central banks update their models, get with the program, and learn how to hit the curveball? Until they do, they will continue to damage the economic conditions despite the well-intentioned academic approach. The economy is not in the academic tower but on Main Street, where central bank and political mistakes continue to hurt individuals and jeopardize the future.

China and Russia are authoritarian governments with leaders that rule with iron fists. In February 2022, Presidents Xi and Putin shook hands on a massive trade package and “no-limits” support agreement. Two iron fists have had an exponential impact on the global geopolitical landscape as it led to Russia’s invasion of Ukraine and could cause China to accelerate plans for reunification with Taiwan. The “no-limits” handshake created a geopolitical bifurcation with the U.S. and Europe on the other side. Democratic leaders in the U.S. and Europe run for office and lead with public mandates. China and Russia could not be more pleased with the recent events impacting those leaders:

• French President Macron lost his Parliamentary majority, which makes his leadership more than challenging.
• British Prime Minister Boris Johnson resigned from his party’s leadership on July 7 and will relinquish his position to another conservative over the coming weeks.
• U.S. President Joe Biden has the lowest job approval ratings in history heading into the mid-term elections, which will likely make him a lame duck over the coming two years. His party is now searching for alternative candidates for 2024.
• The assassination of former Japanese Prime Minister Shinzo Abe is a destabilizing force for another member of the U.S.-European alliance.

The leadership in the U.S. and Europe is faltering at a time when Chinese and Russian leaders have become aggressive. The trends favor Beijing and Moscow over Washington and Brussels regarding the future of the geopolitical landscape.

The high-flying oil and grain markets have corrected over the past weeks, leading many analysts and market pundits to call for the end of inflation. Bull and bear markets rarely move in straight lines, and corrections or rebounds can be fast and furious, shaking the confidence of the most committed bulls and bears. Meanwhile, the Fed is treating the wrong economic condition if inflation is dead. If, as we suspect, it will continue, market experts are misinterpreting a bull market correction in commodities. In either case, both are attempting to pick tops or bottoms in markets, which has more to do with ego than profits or addressing and treating economic woes.

The root causes of supply-side inflation, Russian aggression, sanctions, and Moscow’s retaliation are not going away soon. The collapse of support for French, British, and U.S. leadership only strengthens Moscow and Beijing.

Markets move higher or lower because buyers or sellers become more aggressive. Sentiment drives prices. However, economics and geopolitical events are always in the background, impacting the supply and demand factors. In July 2022, the economic and political backdrop remains a giant mess. Falling liquidity in summer markets exacerbates price moves, confusing many market participants. I believe the recent selloff in the commodities asset class is not the end of inflation but the beginning of stagflation, a condition that the Fed has few tools to conquer. Moreover, the supply-side issues created by the geopolitical tensions and weak Western leadership with declining support pose a danger that the wrong moves could pour fuel on inflation after a brief respite. Central banks have few tools to deal with supply issues.

I favor buying the dip in commodity prices

I favor buying the dip in commodity prices, leaving plenty of room to add on further price weakness. It is virtually impossible to pick bottoms or tops in any market because prices tend to rise or fall to illogical, irrational, and unreasonable levels.

Meanwhile, supply-side inflation is not going away soon, and the geopolitical landscape will likely continue to present unique and unprecedented challenges for traditional energy and food commodities.

The fund summary for the Invesco Yield Diversified Commodity Strategy No K-1 ETF (exchange-traded fund) product states:

PDBC holds a portfolio of fourteen highly liquid commodities. At the $17.63 level on July 8, the ETF had over $8.33 billion in assets under management and traded an average of over 7.48 million shares each day, making it a highly liquid product. The ETF charges a 0.62% management fee.

After reaching a high of $20.76 on June 9, PDBC fell to the $17.63 level at the end of last week, a 15.1% decline. In Q2, PDBC moved from $17.64 on March 31 to $18.04 per share on June 30, 2022, a 2.27% increase. The ETF outperformed the composite of 29 of the most liquid commodities traded on the U.S. and UK futures and forward markets that declined by 6.27% in Q2. The move suggests a concentration in energy commodities and far less exposure to base and precious metals.

Over the first six months of 2022, PDBC moved from $14.06 to $18.04 per share, or 28.3%. Over the same period, the commodity composite rose by 8.74%, with energy up nearly 44%.

PDBC is an energy-centric commodity ETF product that does not issue a K-1 for investors. I favor buying this ETF during the current commodities asset class correction as energy is a supply-side issue with geopolitical factors supporting higher prices.