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Are Rate Hikes the End of the Commodity Run?

• While higher interest rates are generally considered a negative for commodity returns, this is only the case in a positive real rate environment.

• Looking at real rates in 1970 vs. today, we can see that the 1970s commodity bull run continued long after real rates flipped positive.

• Today, real rates remain negative and have continued lower 30 months after their initial flip into negative territory.

• The tardiness of the Federal Reserve (the Fed) in hiking rates indicates the current real rate environment may be even more constructive for commodities than the low real rates of the late 1970s.

After two years of explosive returns in broad commodities, people will begin looking for a reason to call the top. Eric Hewitt, our Director of Research, addressed one potential culprit—the end of hostilities in the Russo-Ukrainian War—in last week’s Two Minute Tuesday, identifying this as merely the gasoline that was poured on the commodities bonfire. Another factor in the commodities expected return function is interest rates, and people may begin to point at rising interest rates as the variable that will put an end to commodities’ historic run. While higher interest rates can be a drag on commodity performance as it becomes more expensive to hold inventories, this is only true if interest rates are outpacing inflation rates, which have the opposite impact (i.e. real interest rates are the ones that really matter).

If we compare the current environment to the last time we saw a similar inflation spike, the late 1970s, we can identify a point in each time period when real interest rates, approximated here as the yield on the 10-year Treasury minus the year-over-year change in the Personal Consumption Expenditures Index (PCE), turned negative. By indexing the Bloomberg Commodity Index to 100 at that point and carrying the performance forward from there, we can get an idea of how the current bull run compares to that of the late 1970s. This also allows us to identify the real rate at which commodities began to falter and contrast with today’s real rate environment.

20220405-chart-1After flipping negative in 1974, real rates turned positive again 14 months later and floated mostly below 3% for the next five years. It wasn’t until a string of aggressive rate hikes in 1980-81, the magnitude of which is unthinkable today, that real rates began to climb steeply and commodity returns began to falter (identifiable in the charts above around month 80).

Today, we have real rates most recently at -3.43% (as of 1/31/22), and the Fed has only just begun to hike rates. Contrasting the Fed Funds Target Rate (FFR, upper limit) with PCE going back to the 1970s, we can clearly see the Fed was in the habit of either front-running inflation or at least hiking rates alongside it. The juxtaposition with the sharp spike in inflation over the last year and no movement in the FFR until March 2022 (not graphed) indicates the Fed may be behind the curve.

20220405-chart-2The current environment is obviously not a perfect mirror of the 1970s, and we shouldn’t expect this market to play out in exactly the same way. However, we’re all familiar with the importance of learning from history and its rhymes, and we believe this case is no different. We are still a long way from positive real rates, and history demonstrates even flipping back to positive real rates isn’t in itself the death knell for commodities. The fundamental drivers of the strong commodities market do not disappear even if the Fed follows through on its new hawkish rate hike schedule. Quite the contrary, it’s possible we enter a situation where small rate hikes have no impact on demand but actually begin to suppress production, thus exacerbating inflation instead of stifling it. To continue Eric’s bonfire analogy, the Fed’s garden hose may not be enough to put out the bonfire.

Important Disclosures & Definitions

An investor should consider the investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus containing this and other information, call 1-866-759-5679 or visit www.alpsfunds.com. Read the prospectus carefully before investing.

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

All investments are subject to risks, including the loss of money and the possible loss of the entire principal amount invested. Additional information regarding the risks of this investment is available in the prospectus.

The Bloomberg Commodity Index (Total Return) (BCOM) is the primary prospectus benchmark for the ALPS | CoreCommodity Management CompleteCommodities Strategy Fund (the Fund). For standardized performance of the Fund, please click here.

Bloomberg Commodity Index: an unmanaged index used as a measurement of change in commodity market conditions based on the performance of a basket of different commodities.

Bull Market: a financial market in which prices are trending upward or are expected to trend upward.

Bull Run: an extended bull market.

Federal Funds Target Rate (FFR, upper limit): the upper bound of the Federal Funds Target Rate range, which is the interest rate range in which the Federal Reserve suggests banks lend overnight reserves to each other.

Hawkish: in relation to monetary policy, describes a more restrictive stance (when the Federal Reserve is hiking or intends to hike interest rates).

Personal Consumption Expenditures Index (PCE): a broad measure of inflation similar to the Consumer Price Index and created by the Bureau of Economic Analysis.

Real rates are approximated as the yield on the 10-year Treasury minus the year-over-year change in the Personal Consumption Expenditures Index (PCE).

One may not invest directly in an index.

ALPS Advisors, Inc. is the investment adviser to the Fund and CoreCommodity Management, LLC is the investment sub-adviser to the Fund. ALPS Portfolio Solutions Distributor, Inc. is not affiliated with CoreCommodity Management, LLC. ALPS Advisors, Inc. is affiliated with ALPS Portfolio Solutions Distributor, Inc.

ALPS Portfolio Solutions Distributor, Inc. is the distributor for the Fund.

JCI000892 04/30/2023

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