Strategists Pick Commodities as a Favorite Way to Play Reflation

As the reflation theme dominates markets, investment strategists are picking commodities as some of their favorite trades.

Even though it seems premature to worry about inflation, investors who are looking for hedges against a hot economy should consider scooping up commodity indexes, oil and energy equities, according to John Normand, head of cross-asset fundamental strategy at JPMorgan Chase & Co.

At Morgan Stanley, Andrew Sheets listed shorting gold against copper as one of his top trades. Evercore ISI says cyclicals, like industrials, energy and materials, are the way to trade expectations for faster growth.

Across Wall Street, strategists are thumbing through their playbooks for ways to position for a sharp recovery out of the pandemic, especially as the Federal Reserve appears ready to let the economy run hot. As goverments make fast progress in vaccinating their populations, the debate among investors has quickly shifted to inflation and how price pressures could ripple through markets.

Here’s what strategists are saying about the reflation trade:

Safe Is Risky?

“Instead of ‘looking up’ for the biggest beneficiaries as growth improves, the more pressing issue for the market may be ‘looking out’ to havens that have so far ignored the improving economic story,” Morgan Stanley’s Sheets wrote Sunday.

Top cross-asset trades include: short gold versus copper, being underweight duration, long the Canadian dollar versus the Swiss franc and the Chinese yuan versus the Japanese yen, and bets on a steepening of the U.S. real yield curve.

Commodity Hedges

The lessons of history, current valuations and carry suggest that the best hedges for a “too-hot economy” are a commodity index, oil, agriculture, energy equities and emerging-market commodity FX, according to John Normand, head of cross-asset fundamental strategy at JPMorgan Chase & Co.

The worst are base metals, gold and G-10 commodity FX, while the “in-betweens” are Treasury Inflation-Protected Securities and mining equities.

Dollar Tailwind

“While not our base case, a rapid and significant rise in U.S. real yields” may add to tailwinds for the U.S. dollar, Barclays Plc strategists led by Ashish Agrawal said in a note Sunday.

Agrawal said the company’s U.S., strategists think a potentially sizable infrastructure plan from President Joe Biden’s administration is beginning to push real yields higher.

Market Duel

“For the start of this week, it’s a fight between rising commodity prices and rising bond yields,” said Kit Juckes. “And the danger is bond yields win.”

The dollar is likely to weaken in due course on a global economic recovery with the Fed set to stay on hold for a long time, he said. The rise in bond yields “is probably going to overshoot on the upside at some point just because we are going to find inflation data that come behind that aren’t that alarming,” he said.

Taper Tantrum

“Cyclicals are best positioned to benefit from the normalization of economic activity,” said Dennis DeBusschere. “Another taper tantrum would weigh on the absolute level of risk assets, but should also benefit cyclicals, especially those most levered to increasing global growth like industrials, energy and materials.”

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