Are Commodities For Trading or

Investing?
Posted on August 12, 2014
Before 1990, there wasnt an easy way for investors to put money to work in a diversified
basket of commodities. Unless you had your own seat on the futures exchange a la Dan
Akroyd and Eddie Murphy in Trading Places or hired a broker who did, it would have been
nearly impossible to include commodities in a well-diversified portfolio.
That all changed in the early 1990s once fund companies were able to set up investment
vehicles to buy and sell commodities to package as investment products for prospective
investors. Once commodities started to show promising performance in the early 2000s more
and more products started popping up in the form of mutual funds and ETFs that made it
much easier for investors to gain exposure to commodities.
This left many long-term investors wondering if it makes sense to include commodities as a
permanent position within their portfolio.
Lets take a look at two of the most well-known, diversified commodity indexes to see how
investors would have done since the early 1990s when the asset class became available for
wider distribution.
These are the performance numbers for the S&P GSCI (formerly the Goldman Sachs
Commodities Index) and the Dow Jones UBS Commodity Index compared to the returns
earned in stocks and T-Bills:
Over this nearly 25 year period, a diverse portfolio of commodities would have earned
investors similar returns to cash with similar volatility to stocks, the exact opposite of what
you would want to see from a long-term asset class. Factoring in inflation the real returns
were 0.37% and 1.45% annually for the respective commodities indexes.
This data makes a strong case that commodities dont make for a solid long-term investment
as a dedicated allocation in a portfolio. They are probably much more conducive to trading
than investing as you can see from this performance breakdown by different periods:
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There have been bouts of strong performance but there are wild swings in the prices of
commodities over time. This makes sense because commodities are really just materials and
input costs. They dont pay dividends or generate earnings like stocks. They dont pay income
like bonds.
It has been argued that the high volatility in commodities could actually help reduce overall
portfolio volatility as a hedge because the returns are uncorrelated with stocks and bonds.
A recent research paper refutes this suggestion by showing that commodities
actually increase overall portfolio volatility with a decrease in risk-adjusted returns.
Many investors and financial advisors saw the huge returns in the early-to-mid 2000s as a
signal to increase their long-term allocation to commodities. The data shows that this was
probably a mistake.
Commodities appear to be a trading vehicle, not a viable long-term investing option.
Further Reading:
Do you need commodities in your portfolio?
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11 THOUGHTS ON ARE COMMODITIES FOR TRADING OR INVESTING?
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Trade Commodities
CFDs
plus500.at/Commodities
Trade Commodities- No trading
fees! Be Smart. Your capital is at
risk.
Doug Simmang
on August 12, 2014 at 8:57 pm said:
Excellent information Ben. Thank you. Would love to hear your thoughts on the
permanent placement of Treasury Inflation-Protected Securities in a well diversified
portfolio too.
Ben
on August 13, 2014 at 9:14 am said:
Thanks. I do have some thought on TIPs. Thats a great idea for a future
piece.
Marc
on August 13, 2014 at 3:31 pm said:
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Thanks for the hard data and thoughts. I placed 2% of my portfolio in commodities (in
USCI) three years ago as a long term diversifier. This article convinces me that this
was not one of my better moves (live and learn). As of now my commodities fund
position is down 17%, however, given the large volatility that your data shows, it
seems more sensible to wait for an up period to sell, rather than get out now. Do you
agree?
Ben
on August 13, 2014 at 10:42 pm said:
I cant offer you specific advice but heres a way to frame this decision: what
would you regret more missing out on future gains in commodities if they oc-
cur or taking part in more losses if they occur? Every investment decision can
be looked at through the lens of opportunity costs. Think about it that way be-
fore making a choice either way.
Ben
on August 13, 2014 at 10:43 pm said:
Also dont necessarily consider this a bad move just because you got a bad
outcome. You have to figure out why you chose to add commodities in the first
place.
Kiat
on August 14, 2014 at 10:40 am said:
I find commodity to risky an investment, there is certain life span to it, unlike stock if
you buy into good company they can last for hundred of years if not forever.
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