Not Time to Exit Commodity Positions

Diversified commodities have suffered approximately the same one-year decline as stocks, but the descent has been more violent since broad commodity indexes peaked in the middle of 2008, whereas most stock indexes peaked in October 2007. Just as it is not the time to abandon stock market commitments, this is certainly not the time to exit commodity positions in the context of a diversified multi-asset portfolio.

Cyclical commodities are not a valuable hedge to a stock portfolio in a deflationary bust and a liquidity crisis such as we have seen, but those conditions are not likely to persist over any investment horizon measured in years rather than months. Massive government reflation and stimulus efforts will support hard assets in 2009. Infrastructure spending is bullish for commodity prices, and tighter credit conditions, along with lower prices, puts pressure on the supply of commodities as suppliers curtail production.

Gold finished the year on a very strong note and managed to produce another year of positive returns in 2008. Gold has the most attractive three and five year annualized returns of all the asset classes we track. Gold will continue to be whip-sawed by the volatility in the currency markets.

We hold Gold (GLD) in our portfolios as an insurance policy against financial crisis and paper currency devaluation. The opportunity cost of holding gold, which produces no dividend or interest income, is now very low given that the Federal Reserve has cut the official U.S. overnight lending rate to zero to 0.25%, and has stated that “weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

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