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- Industrial metals like copper and zinc are the "clear winners" of an environment in which inflation is rising, according to Citi strategists.
- Worries about inflation in the US are said to be partly responsible for the recent selloff in the stock market.
- Citi recommends buying the Bloomberg Industrial Metals Sub-index, which consists of futures contracts on zinc, aluminum, copper, and nickel.
Industrial metals like aluminum and copper offer the best opportunity to profit from a rising inflation environment, according to Citi.
Concerns about inflation became full-blown on Friday, when the January jobs report showed the fastest rise in average hourly earnings since 2008. This was a catalyst for the sell-off that was amplified by a sudden spike in volatility, as investors realized that the Federal Reserve may soon have to cool an inflation threat by raising interest rates.
We're now reckoning with the end of the so-called Goldilocks environment - a period characterized by stable growth, low volatility, low inflation, and low interest rates - according to Jeremy Hale, the head of asset allocation and global macro at Citi.
"One asset class stands out as a clear winner under the assumptions of reflationary macro backdrop," Hale said. "Commodities outperform on both absolute annualized returns and a Sharpe ratio basis relative to all other fixed income and equity market."
Instead of picking individual commodities, Hale recommended buying the Bloomberg Industrial Metals Sub-index, based on its price of 133.37 at 3:21 a.m. ET Thursday. The sub-index consists of futures contracts on zinc, aluminum, copper, and nickel.
Inflation benefits industrial metals because their prices rise alongside the cost of production for companies that rely on them, Hale noted.
The jobs report wasn't the only sign of higher inflation, even if it was one of the tipping points for the recent stock-market decline. For example, Hale noted that the Institute of Supply Management's index of prices that manufacturers pay for raw materials is at its highest level since May 2011.
"What the last days have certainly shown us is that we have probably moved out of the low vol QE driven world," Hale said. "And especially if we do move into a reflation phase (higher growth, higher inflation) then expect risk-asset Sharpe ratios to be worse. This could improve conditions for macro traders."
Hale said the risk of this recommendation is if China, one of the world's largest consumers of metals, experiences a growth slowdown.