The challenges of investing are many. Think back to the middle of 2006. The commodity markets, driven in large part by energy prices, were booming. Every one and their brother were touting the benefits of diversifying your portfolio with long-only, commodity funds. Indeed a raft of commodity-focused ETFs came to market to fill this very need.
What happened? Energy prices cooled. The performance of commodities lagged the surging stock market and nearly every one who bought into the hype is now disappointed. Newly formed hedge funds that were launched to take advantage of the “inevitable” rise in commodity prices are now facing more sober times. It is perfectly natural to wonder whether to hold onto commodity funds that are now, in all likelihood, underwater.
As we noted at the time, the commodity diversification hype came at a unique time. At the same time commodity prices were surging, along came academic research that “proved” commodity diversification was a very attractive proposition. With that came a surge of interest that may have eliminated one of the important sources of returns, the so-called “roll return.”
It may very well still be the case that commodities are a good portfolio diversifier, but the time to add them was not amidst a full-scale boom. A patient investor, with a longer time horizon, will proactively use periods of prices weakness to round out their portfolio. Recent commodity market returns are decidedly negative, and talk of $40 a barrel oil abound.
That is not to say that all commodity prices dropped during this time period. Agricultural commodities, in particular grain prices, have surged in the interim, along with all the incumbent problems of new participants playing in these once-cozy markets. And to no one’s surprise there is now an ETF to play this trend as well. While the agricultural commodity price boom may continue, a more diversified stance is preferred route for the investor with a longer time horizon.
We frankly have no idea what commodity prices will do over the short or long run. There is a decent case to be made for adding a dollop of commodities to your portfolio for diversification purposes. However, commodities are not the “perfect” asset class. You cannot count on low correlations with equities and equity-like returns in every time period. If you think you missed out on the boom last year, consider yourself lucky. The markets may very well be giving you another opportunity to make commodity funds a part of your portfolio, along with better tempered expectations.