The physical capital paradox: why the best performing asset class is the least owned

Commodities have been the best performing asset class since October 2020, with the S&P GSCI up 200% and gold up 140%, yet investors hold less than 6% in energy and basic materials, down from a long-run average of 18%, creating what Jeff Currie calls the physical capital paradox. Currie argues that the AI buildout is driving a massive resource demand shock—the Magnificent Seven will spend nearly $800bn this year, half on raw materials and energy—while investors refuse to fund the resources themselves, despite the Munificent Seven oil majors offering 14-15 cents of free cash flow per dollar of market value versus 2 cents for tech stocks.

The physical capital paradox: why the best performing asset class is the least owned Investors are ignoring the superior performance of commodities despite their critical role in the AI buildout, says Jeff Currie The best performing asset class of this decade is also the most under owned. Since October 2020, when we first called for a decades-long super-cycle in commodities, the broad commodity indices like the S&P GSCI are up 200 per cent; gold 140 per cent. This year commodities are up 37 per cent with petroleum up 81 per cent. The bottlenecks rotated – gold, copper, silver, coffee, cocoa, oil and most recently diesel. But not the trend. In contrast, crypto indices are up 157 per cent, the Nasdaq 145 per cent and the S&P 500 117 per cent. By investor returns, hard assets have beaten technology. You would never know it by what investors hold. Energy and basic materials represent less than six per cent of the S&P 500, less than a third of its long run weight. During the first part of this decade institutional investors used sustainability as a reason to dissolve real-asset sleeves, yet poured money into green energy that required vast amounts of raw materials like copper. Six years on, superior returns have produced little reallocation. Performance is supposed to attract capital, but it hasn’t. That is the physical capital paradox. What makes this even more remarkable is what the capital chased: the artificial intelligence buildout, the largest commodity short in history. The Magnificent Seven will spend nearly $800bn this year, of which close to half is for raw materials and energy: copper for power transmission, critical minerals for hardware, fuel and electricity for datacentres. The energy footprint of the five biggest buyers of AI compute is nearly 4m barrels of oil equivalent a day, more than most major industrialised nations. Investors have funded one of history’s largest resource demand shocks while refusing to fund the resources themselves. And that demand shock is not peaking, it’s compounding. The conventional view is that the age of mechanisation came first and the digital age followed. We would argue the sequencing goes the other way. What the 20th century mechanised was repetitive and structured, because the binding constraint was not horsepower, it was cognition. Think the assembly line, the tractor, the loom. A century into the machine age, 80 per cent of physical work is still done by human hands, and artificial intelligence removes that constraint. Now the real age of mechanisation can be realised, and every robot is copper, rare earths, batteries and joules. Magnificent Seven vs Munificent Seven Compounding the paradox, investors could hardly be better paid to correct the mistake. In contrast to the Magnificent Seven https://www.cityam.com/why-even-gilts-are-outperforming-the-once-unstoppable-magnificent-7-this-year/ stands the Munificent Seven: ExxonMobil, Chevron, ConocoPhillips, Shell, TotalEnergies, BP and Equinor, the western majors supplying the AI buildout’s energy. The munificence is literal. These companies hand back 14 to 15 cents of free cash flow per dollar of market value, against roughly 2 cents for their magnificent counterparts. One group is priced for a future it may not fully capture while the other is paying handsomely in the present and priced as if the present were about to end. Today diesel and gasoline margins are at record levels as the war in Ukraine ravages stretched supply infrastructure, yet the Munificent Seven trade lower than before the US-Iran war. Rarely has the market offered such generous terms to hold what it needs most, and rarely been so completely declined. The refusal has its reasons, none of them about price. A generation of allocators carries the scars of the 2010s, when the capital destruction from funding energy and metals projects was nothing short of epic. Today, however, passive vehicles allocate by size, not by price, mechanically buying whatever is largest and trending. The paradox persists: the marginal buyer is no longer looking at the price signal. This tells you how it ends. Another year of best performing returns is unlikely to shift allocations. What will reprice under owned physical assets is a crisis, not the returns. It is the moment the physical world fails to deliver, which is knocking on the door. In the 1970s energy allocations surged because fuel ran short, not because energy returns rose. In the 2000s investors ploughed into metals because China emptied warehouses. Investors followed scarcity you could see: the queue, the empty shelf or the outage. The system is now poised to create that crisis. Record margins are not being met with new investment. Investors are funding record demand growth while starving the supply side, with more mechanisation to come. At the same time the insurance policies are being exhausted: spare capacity, inventories and strategic reserves. The next disruption, which is already underway, will be experienced, not talked away. The paradox will likely end abruptly, through a physical crisis that makes it impossible to ignore. The best returns in the market are transparent, but the market is unlikely to claim them until it is forced to. When that day comes the capital will arrive in abundance and at a higher cost. It was visible the entire time, it just wasn’t owned. Jeff Currie is chief strategy officer at Altis Partners