UBS: Commodities can add diversification as inflation, geopolitical risks rise

Commodities may become a more significant part of diversified investment portfolios, according to UBS. As investors grapple with rising inflation, geopolitical instability, and the need for energy and industrial materials, broad exposure to commodities can offer diversification and new sources of return. While gold has been a popular hedge, UBS suggests exploring other avenues.

UBS argues that commodities can provide access to underrepresented sectors of the global economy that are not as well-represented in local equity markets. Additionally, they can potentially shield portfolios from shocks that impact stocks and bonds. The case for increased commodity exposure has strengthened due to several factors.

Gold prices surged by around 10% in August, presenting an opportunity for investors with substantial gains to lock in profits and diversify their portfolios. Simultaneously, increased risks to energy supplies following conflicts in the Middle East, coupled with robust oil demand, could support crude exposure in the long run. Industrial metals also benefit from structural support, driven by electrification, rising power demand, and investments in artificial-intelligence infrastructure.

UBS's analysis of developed-market equities and commodities shows that their correlation has decreased over three- and six-month periods over the past year. In simpler terms, commodities tend to rise when stocks fall, potentially helping to cushion portfolios during market stress. Currently, UBS recommends a mid- to high-single-digit allocation to commodities within a diversified portfolio, which can provide meaningful diversification without taking on excessive risk.

The appropriate allocation depends on individual investors' objectives, risk tolerance, and market outlook, with regular rebalancing crucial as circumstances evolve.

Gold remains a key diversifier in UBS's view, supported by central-bank demand, the continued need for dollar diversification, and concerns over global debt. The bank remains optimistic about gold over the next 12 months but advises investors with significant gains to consider reallocating some exposure to other commodities. However, UBS warns that commodities may be susceptible to volatility, as they often perform best when supply-demand imbalances or macroeconomic risks like inflation and geopolitical shocks are high, leading to sharp fluctuations in returns as these forces change.