Three Foundational Beliefs of the GDC Investment Philosophy
A foundational belief of the GDC investment philosophy is that the time and sizing of exposure to commodity beta matters greatly and should be dynamically managed. There are two reasons why.
First, commodity futures prices are inherently volatile due to the periods of uncertainty that may surround endogenous variables such as the production, consumption, transportation, and storage of the underlying physical goods. During periods of dislocation, there is often the potential for volatility spillover from one sector to another. For example, during an energy crisis, supply of industrial metals may be constrained as rising energy prices or reduced accessibility to power cause the marginal cost of production to rise.
Therefore, depending on the rate of change of these variables, both independently and in relation to one another, prices can exhibit varying levels of volatility through time. Notably, during commodity bull markets, when supply-demand balances become strained and inventories are drawn down, the level of volatility tends to rise in line with prices as supply buffers are depleted and fears of scarcity rise. During such times, the dynamic management of commodity futures exposure should prove advantageous.
Secondly, commodity beta requires dynamic management because commodity futures prices are also subject to exogenous dynamics. For example, markets as diverse as oil, copper, gold, wheat, and sugar may all be influenced by changes in interest rates, currency values, and geopolitical events. At the extreme, commodity markets can be badly affected by financial panics, when the assumptions that underly asset allocation models are invalidated as all risk assets become highly correlated. Examples of such events include the Global Financial Crisis of 2008-09 and the Pandemic Shock of 2020. Once again, the dynamic management of commodity exposure in relation to endogenous factors influencing the asset class should benefit the investor.
A second foundational belief of the GDC investment philosophy is that capital growth over the lifetime of an investment is congruent with the aspirations of the investor and the manager. Unlike other asset classes, returns from commodity futures originate almost exclusively from capital gains and losses, rather than the more usual combination of capital movements and income so familiar in equities and fixed income.