Commodity ETFs: Handling the ‘Quirks’ in Commodity Trading Patterns

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Commodity ETFs are not without allure. And With good reason; it wasn’t long ago that only the biggest, baddest investors could invest in them. Today, anyone can. But watch out for surprises.

Case in point: in 2008, the stock markets got nasty and commodity indexes moved practically in lockstep. It’s been well-documented that even as commodity prices gain, ETFs don’t necessarily mirror the gains 100%. It has many investors asking whether commodity ETFs truly boost returns and reduce risk, Rob Curran for The Wall Street Journal reports.

A landmark paper authored by a Yale professor and a University of Pennsylvania professor in 2004 examined those very questions.

Among the findings:

  • Researchers found a negative correlation between commodities and the other assets during the period between 1954-2004. One of their most influential findings: commodities had above-average returns during months of below-average returns for stocks in that 45-year period.
  • This does not mean that this is the rule. Both asset classes can also move in the same direction, as many have found.

One theory for the unusual trading patterns was floated by Paul Justice at Morningstar, who believes that the similarity could be coming from the fact that the participants in both markets are becoming more similar. Those participants may also be looking at commodity ETFs less as a portfolio diversifier than past participants have.

Where does that leave us? If you can’t roundly count on commodities to rise when stocks fall or vice versa, try implementing a simple strategy and ride the trends until they vanish. We follow the 200-day moving average (you can read about it here).

Disclosure: None