Some commentators are already dubbing 2022 ‘The Return of History,’ thanks to its combination of resurgent Russian aggression, the first significant bout of inflation many Americans have ever experienced, the continued growth of an increasingly menacing superpower in China and – oh yes – an ongoing global pandemic.
Historically speaking, financial advisors and investors turned to commodities in tumultuous times to provide a non-correlated hedge against volatility in the equity and fixed income markets. While choked-off supply chains and transportation routes can create havoc for global manufacturers, they can also drive gains for commodities investors – especially in inflationary environments like the one we’re experiencing now.
Today’s market participants, however, have advantages that previous generations lacked when it comes to commodities-focused hedging strategies. Thanks to innovative applications of a technology that many ironically associate with heightened volatility – the blockchain – current investors have access to hedging strategies and emerging stores of value in the commodities markets that didn’t exist just a few years ago; not to mention ever-increasing transparency and efficiency in the way these markets function.
The blockchain and digital assets
Although Bitcoin futures began trading in 2017, widespread use of crypto futures in broader commodities funds received a significant boost with the launch of the first Bitcoin futures ETFs just last year. Given their finite supply dynamics and growing adoption in financial transactions across the world, cryptocurrencies have proven themselves well-suited for various commodities-focused investing strategies that provide diversification and hedging protection for both institutional and retail investors.
Over the past year, large asset managers such as Neuberger Berman have moved to add crypto-focused strategies to existing commodities fund offerings, enabling investors to add indirect exposure to bitcoin, ethereum and other cryptocurrencies and digital assets through futures, trusts and ETFs. While the correlation between crypto and equity markets has changed from year to year, expanding these funds to include digital asset futures and other vehicles enables investors to hedge their portfolios against equity market volatility – and inflation – in ways that would have been out of reach even 10 years ago.
Blockchain technology is also making commodities markets themselves significantly more efficient and secure, allowing trading partners to quickly access a common ledger of transactions; implement electronic know-your-customer (KYC) standards; and expedite regulatory approvals, among other benefits.
Unlocking new stores of value
Even more important than creating new crypto-driven hedging strategies, however, is the blockchain’s ability to unlock new stores of value by forcing price discovery and transparency across previously fractured and illiquid markets. This is playing out thanks to the trend referred to as ‘tokenization.’
Most investors have heard of tokens at this point – most visibly NFTs, which many associate with ownership of virtual goods. Blockchain innovators, however, are rapidly using tokens to make a wide array of physical alternative investments – including art, wine, whiskey and even real estate – accessible and transparent to a far broader audience.
In the commodities markets, tokenization is opening new investment and hedging opportunities involving assets that have long held tremendous value, but which have also been notoriously opaque, fragmented and secretive when it comes to their global supply and markets – namely, diamonds and other precious gems.
Diamonds provide a strong example of the potential hedging benefits of commodities tokenization for investors. As the COVID pandemic took hold in late 2019 and early 2020, many diamond producers drastically curtailed or even shut down their mining and cutting operations, leading to serious global supply constraints. According to a Bain & Company report, those supply restrictions drove price increases of 21% for diamonds in 2021 – and created a potential inflationary hedge for investors.
The Russian invasion of Ukraine may drive continued price increases over the next five years, as Russian-owned Alrosa – the world’s largest diamond producer by volume – has been sanctioned because of the conflict, thus further constraining supply.
Without question, the turmoil we’ve seen so far this year has been unsettling for markets and investors. At the same time, surging inflation has jeopardized portfolio values and retirement savings for many.
One silver lining, however, is that investors and financial advisors today have more ways than ever to add alternative assets and commodities as hedging strategies to guard their portfolios and their clients against both capital markets volatility and inflation. A potential gold lining is that some of these newly accessible assets will generate outsized returns, as the demand from investors building first-time positions drives up prices.
Whether by creating entirely new commodities asset classes, improving the efficiency and transparency of existing commodities markets or unlocking new stores of value, the blockchain has proven itself a powerful force in helping advisors and investors weather the turbulence of our current historical moment.
