Investors have always been advised to diversify their investments. For most investors there are three main “baskets” — stocks, bonds and cash. However, according to some thinking there is another one – commodities. That leads to the natural question: should typical investors venture into that basket?
Commodities are things like gold, silver, oil, wheat and corn. What are the pros and cons investments in them, and how do they differ from investments in the traditional baskets?
The purpose of stocks and bonds is to raise money for the corporation. A bond can be valued by examining its interest-rate and its probability of default. A stock can be valued on its forecasted future earnings and dividends. These are all uncertain and investors are paid to bear this uncertainty.
Commodities are different. Investors usually don’t invest directly into commodities. They generally invest either directly or indirectly in commodity futures. These securities are a short-term wager on the future value of a commodity. Indirect investments in commodity futures are available through exchange-traded products (ETPs), sector mutual funds and managed future pools.
Commodity futures are unlike stocks or bonds. Their purpose is to allow firms to obtain insurance against the future value of their commodity. There is nothing to value — no earnings or dividends or interest-payments. Investors are simply betting on the short-term price fluctuations of the commodity and are paid to bear that uncertainty.
The simplest way for typical investors to add the commodity basket is through commodity index mutual funds or ETPs. The latter trades on a stock exchange just like any stock and the former is bought just like any mutual fund.
The key question: Is it worth doing? Certainly not for investors without enough patience. Over the last decade, based on commodity fund returns, they lost money in more years than they gained. For example, a $10,000 “investment” in the Bloomberg Commodity Index at year-end 2010 would be worth less than $5000 at year-end 2018.
One study of the period 1959-2004 by Gary Gorton and K. Geert Rouwenhorst provides some insight into the possible very long-term value of an investment in commodities. They reported that an equally weighted index of commodity futures had similar returns to the S&P 500 with lower volatility, was negatively correlated with stocks and bonds and positively correlated with inflation.
The research firm SummerHaven Investment Management built on this study. Their research also suggested that for investors with enough patience, commodities could offer promise. They did a comprehensive study of commodity returns going back to 1871. They concluded that commodities outperformed cash by an annualized 5.2%. For context, U.S. stocks outperformed cash by an annualized 5.5% for the period 1900-2018.
Even with this data, in my view commodities are suitable only for aggressive investors. Even for those, the role of commodities, due to their negative correlation, is to try to offset equity losses in a severe market downturn. So, for an allocation to commodities to be really productive several severe market downturns may be needed.
All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.
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February 24, 2020 at 06:44PM
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Are commodity investments worth making for a typical investor? - Sarasota Herald-Tribune
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