Commodities are cyclical in nature. Returns on commodity investments aren’t generated in a vacuum — they’re influenced by a number of economic forces. In other words, the performance of commodities, like that of other major asset classes, is tied to general economic conditions. Because economies move in cycles, constantly alternating between expansions and recessions, commodities react according to the current economic phase.
The performance of commodities as an asset class is going to be different during economic expansions than during recessions.
As a general rule, commodities tend to do well during periods of late expansions and early recessions. The reason is that, as the economy slows, key interest rates are decreased to stimulate economic activity — this tends to help the performance of commodities. Stocks and bonds, on the other hand, don’t perform as well during recessions.
As an investor seeking returns across all phases of the business cycle, opening up to commodities enables you to generate returns during good and bad economic times.
The study of cycles, whether for commodities, stocks, or other assets, isn’t an exact science. Don’t use cycles as the foundation of a trading or investment strategy. Instead, try to use the study of cycles to get a sense of what historical patterns have indicated — and where an asset class is heading.
Although the historical pattern of commodities tends to show better performance during late expansions and early recessions, this in no way guarantees that commodities will keep following this pattern. Actually, during the latest commodity bull market, commodities have acted independently of the business cycle. This performance may be attributed to the fact that this commodity bull market is a different beast than in previous cycles.