Is it time for Alternatives?

“Alternatives” is a blanket definition, encompassing anything that doesn’t fall strictly within equities or bonds. Commodities now fall under the general umbrella of Alternatives. The proliferation of derivatives creating many hybrid assets, such as hedge funds and structured products, while private equity and other real assets are now also included in the mix.

In the past few months, we have experienced two major structural and intertwined shifts: the resurgence of inflation and the shift from a unipolar to a multipolar world.

Let’s pick up the first, inflation. Traditionally, and contrary to common wisdom, bonds have fared slightly better than equities in times of inflation on a short-term 12–18-month basis, while equities have tended to outperform longer-term, over a three-year basis.

Commodities, however, be it a generic commodity index or gold, have outperformed both during times of high inflation. There are nuances of course, including timing and speculation in commodities, which has increased significantly after 2005 – a period of low inflation. Still, the principle is sound. Where inflation reduces the value of currencies, all other things being equal, the value of commodities and precious metals should rise to compensate.

But inflation is just one aspect and one could argue that chronically restrained demand after the Global Financial Crisis and the labour market’s loss of leverage over time would keep inflation at bay. It may not be our main argument, but we would not reject it out of hand.

The bigger and more undeniable theme is the shift from a post-Soviet unipolar world (one where the American trade agenda dominated) to a multipolar world, with America and NATO at one end and China-cum-allies at the other, while third countries ( countries that are not members of the EU nor a citizen of Iceland, Lichtenstein, Norway or Switzerland ) will oscillate between the two, bargaining for leverage. This theme requires the building of “fortress trading blocks”, in essence, the cultivation of a high degree of self-sufficiency between allies, with the rest of the resources procured from third countries at a higher cost.

This sort of transition will require vast investment in infrastructure. It is not too difficult for a factory to be relocated from Shanghai to Chennai, or even Philadelphia for that matter. But it is a more daunting task to create the roads and energy resources around it.

This theme will, inescapably, push up prices for commodities. Countries will also spend a lot on infrastructure, traditionally an “Alternative” asset.

In the world of lower real incomes, either due to inflation or constrained demand, the next few years may well belong to commodities and infrastructure.

George Lagarias, Chief Economist