Commodities: Diversification With Moderation

Roger Nusbaum submits: Tom McManus was on CNBC earlier today and the discussion drifted to what would be an appropriate weight for commodities in a diversified portfolio.

I have written more times than I can count about my belief that commodities are a crucial element to being diversified. I have heard in various interviews that anywhere from 5-15% should be in commodities. I have never been a proponent of a double digit weighting.

Right now just about every one of my clients has the streetTRACKS Gold Trust ETF (GLD) at a 2-3% weight, and some clients own a big, foreign, diversified miner at 2%, and that is it for direct exposure. I do think of Plum Creek Timber Co. Inc. (PCL), which I have disclosed owning previously, as being different, and PortfolioScience backs me up saying that its correlation to GLD is 0.057. And although I don't own it anywhere, PCL's correlation to the PowerShares DB Commodity Index Tracker (DBC) is also quite low at 0.026.

Kind of in the commodity 'arena' is the Australian bank I own for clients, but its correlation to GLD is 0.359, and a few people own CVRD (RIO) and a Chilean bank, which correlate to GLD at 0.429 and 0.187 respectively.

I don't view the above as particularly heavy, but you may view it otherwise. I should add that no client has all of the above.

I find that there is a lot of extreme positioning and commentary available out there, and while I find utility in reading the arguments made, I don't find much utility in the positioning.

All of the commodity naysayers will tell you that commodities are volatile and difficult to time well. Hello—they are right! The volatility (this is a euphemism for decline) of late is exactly what they mean. My first post on gold two years ago said that stocks tend to zig when gold zags. This summer captures it perfectly.

On more than one occasion, I have said here that I do not want gold to ever be the best performing thing I own, because chances are things will then look rough elsewhere.

Another thing I have preached is that not everything should be going up at the same time. If they are, you are not diversified enough. Lately gold and oil have declined, but a lot of other things have been working. While it is true I have lagged this summer, the fact is some things are up a lot; look at Walgreen Comp. (WAG) and Target Corp. (TGT).

The action recounted in this post is the playing-out of almost every theory I subscribe to. Despite getting a couple of big things wrong, client accounts are going up. I still think it turns, but even if I stay wrong, the impact for clients is much less than had I been only 30% invested.

Good stuff!