Some commentators are already dubbing 2022 “The Return of History,” thanks to its combination of the resurgence of Russian aggression, the first major bout of inflation many Americans have ever experienced, the continued growth of a superpower increasingly threatening in China and – oh yes – an ongoing global pandemic.
Historically, financial advisors and investors have turned to commodities in tumultuous times to provide uncorrelated hedging against equity and fixed income market volatility. While strangled supply chains and transportation routes can wreak havoc for global manufacturers, they can also create gains for commodity investors, especially in inflationary environments like the one we are experiencing today.
Today’s market participants, however, have advantages that previous generations lacked when it comes to commodity-focused hedging strategies. Through innovative applications of a technology that many ironically associate with increased volatility – blockchain – today’s investors have access to hedging strategies and emerging stores of value in commodity markets that did not exist a while ago. just a few years old; not to mention ever-increasing transparency and efficiency in the operation of these markets.
Blockchain and digital assets
Although bitcoin futures began trading in 2017, the widespread use of crypto futures in broader commodity funds received a significant boost with the launch of the first bitcoin futures ETFs. last year. Given their limited supply dynamics and growing adoption in financial transactions across the globe, cryptocurrencies have proven to be well suited for various commodity-focused investment strategies that offer diversification and protection. hedging for institutional and retail investors.
Over the past year, major asset managers such as Neuberger Berman have moved to add crypto-focused strategies to existing commodity fund offerings, allowing investors to add indirect exposure to bitcoin, to ethereum and other cryptocurrencies and digital assets through futures, trusts, and ETFs. Although the correlation between the crypto and equity markets has changed from year to year, the expansion of these funds to include digital asset futures and other vehicles allows investors to hedge their portfolios against the stock market volatility – and inflation – in ways that would have been out of reach even 10 years ago.
Blockchain technology also makes commodity markets much more efficient and secure, allowing trading partners to quickly access a common ledger of transactions; implement electronic know-your-customer (KYC) standards; and expedite regulatory approvals, among other benefits.
Unleash new stores of value
However, the ability of blockchain to unlock new stores of value by forcing price discovery and transparency in previously fractured and illiquid markets is even more important than creating new crypto-based hedging strategies. This plays out through the trend called “tokenization.”
Most investors have heard of tokens by this point – most visibly NFTs, which many associate with the ownership of virtual goods. However, blockchain innovators are rapidly using tokens to make a wide range of physical alternative investments – including art, wine, whiskey, and even real estate – accessible and transparent to a much wider audience.
In commodity markets, tokenization is opening up new investment and hedging opportunities involving assets that have long held enormous value, but have also been notoriously opaque, fragmented and secretive when it comes to their supply and markets. world, namely diamonds and other precious stones. .
Diamonds provide a good example of the potential hedging benefits of commodity tokenization for investors. As the COVID pandemic took hold in late 2019 and early 2020, many diamond producers drastically reduced or even stopped mining and cutting operations, leading to severe global supply constraints. According to a report by Bain & Company, these supply restrictions have resulted in price increases of 21% for diamonds in 2021 – and created a potential inflationary hedge for investors.
Russia’s invasion of Ukraine could lead to continued price increases over the next five years as Russian company Alrosa – the world’s largest diamond producer by volume – has been sanctioned over the dispute, further limiting the offer.
Without a doubt, the turmoil we have experienced so far this year has been destabilizing for markets and investors. At the same time, soaring inflation has jeopardized the value of many people’s portfolios and retirement savings.
The good thing, however, is that investors and financial advisors today have more ways than ever to add alternative assets and commodities as hedging strategies to protect their portfolios and clients from financial market volatility. and inflation. A potential golden lining is that some of these newly accessible assets will generate outsized returns as demand from investors creating positions for the first time drives prices higher.
Whether creating entirely new commodity asset classes, improving the efficiency and transparency of existing commodity markets, or unlocking new stores of value, blockchain has proven to be a powerful force for help advisors and investors navigate the turbulence of our current historic moment.