Commodity markets and the long-run - Follow industrial production and inflation

Commodities have been suffering from the continued downturn of the current super-cycle. Commodity super-cycle can last for more than twenty years although individual markets and commodity sectors may follow their own cycle paths that can be shorter.  The question is whether this is the time to get increase exposure to commodities.  

Clearly, after the shock in March and April, there has been a rebound. Energy prices are off their lows, precious metals have seen significant increases in demand, and selected industrial metals and agriculture markets have moved from lows. For example, copper is above highs from a year ago and have retraced all of its earlier loses this year.  However, the real question is whether macroeconomic conditions are right for commodities.

To answer the question of whether to hold commodities, we can look back to data over the last century.(See "Predictability in Commodity Markets: Evidence From More than a Century") The researchers attempt to answer a number of question and look at individual markets and not indices, but their conclusions with respect to macro factors are clear. Industrial production growth and inflation are predictive variables for commodity prices both in-sample and out-of-sample. The researchers find that these predictive variables are more predictive during market expansions. 

They also find that the introduction of futures markets generally increases the efficiency of commodity markets, but that means that macro factors are less predictive, and volatility actually increases.  

For the investor the key is making an assumption about growth and inflation. If both those are expected to rise, holding some commodity exposure makes good sense for both return and diversification. Both these factors may grow at a slower rate than expected two months ago, so there is time to make any appropriate portfolio adjustments.