By Jared Cummans
Investing in commodities has certainly picked up in recent years, but it seems that the overall industry has begun to experience some growing pains. As is common with newer investment types (not that commodities are new, but their heavy popularity is), analysts will lash out and tell investors why this asset class is bad news. Such is the case with a recent article in the Wall Street Journal entitled “The Case Against Commodities“. This piece outlines a number of the dangers and issues that come along with commodity investing. But investors shouldn’t take it at face value, as there are a number of factors that WSJ neglected to mention.
1. Commodity Investing Was Designed For Traders/Hedgers
It used to be that the only way to gain access to commodity investments was through complicated futures contracts, whose stipulations and requirements did well to scare off less-serious investors. The contracts were also used by farmers to hedge against rapidly changing crop prices and to ensure a certain value for key crops no matter what the spot prices were at harvest time. Back then, nobody had a problem with commodities as an investing asset class, as the only people using them were the ones that truly understood how to use them. But with the expansion of the commodity investing sector, the average Joe can now buy an ETF or stock that grants them exposure to these very same commodities. The issue here isn’t that the funds are bad investments, but that they’re used by those who do not fully understand them [see also 50 Ways To Invest In Gold].
Commodities feature hefty volatility and can turn on a moment’s notice, which is why they’re reserved for those willing to actively monitor positions. Assets like natural gas have come under fire for erasing gains in a portfolio, but the majority of these investments should measure their holding periods in minutes and hours rather than days and weeks. That’s not to say that these investments shouldn’t be held for a long period of time, they just need a watchful eye to ensure they are behaving rationally. For those willing to put their nose to the grindstone and closely watch their commodity investments, they can make a healthy return even in a long term scenario. But those who invest and fail to actively monitor will likely be crushed in the long run.
2. Commodity Returns Are Cyclical
Commodities tend to experience ups and downs based on market and global trends. Right now, for example, commodities are on their way down, but going back to active traders, a short position would be yielding handsome gains. Though the unsteady nature of these investments is ultimately addressed by WSJ, it is not fully explored. The author states that commodities have become popular in retirement portfolios, but simply do not belong there. On the contrary, a commodity investment can be a major boost to a retirement portfolio; they just need to be more actively monitored. If utilized properly, solid commodity exposure can yield benefits like inflation hedges as well as low correlation to equity markets [see also 25 Ways To Invest In Silver].
Still not convinced? Take a look at the returns in the DB Commodity Index Tracking Fund (DBC), a broad-based commodity product versus the S&P 500 over the past five years. DBC has shot up 11.23% while the S&P is down about 12%, rewarding DBC shareholders with a major boost to their smashed equity investments. Though most long-term investors do not want to keep a watchful eye on their portfolio, seeing the massive difference in these two returns may be enough to convince some that monitoring your commodity exposure will certainly be worth the hassle.
In another section of the article, the author states that corn prices nearly tripled between 2000 and 2010, while rye barely doubled, commenting on how quickly commodities can be phases out of their usefulness, as corn has become much more prevalent than rye. While this might be true, doubling or even tripling stock price between 2000 and 2010 was a massive feat, and one that the S&P 500 miserably failed to do. Other than a few diamonds in the rough, the majority of U.S. stocks finished out “The Lost Decade” relatively flat, while commodity exposure could have softened the blow [see also Inside Copper’s Plunge: How To Make A Play].
Along the same lines, the author makes his argument that commodities are constantly being phased in and out, citing whale oil as a once popular commodity that is now altogether useless. What the author fails to acknowledge is that while one commodity is phased out, another surges in popularity. When whale oil began to die down, petroleum and crude began to surge, and innovation in new technologies simply yield opportunities to get in on the ground floor of a new commodity. Again, this ties back to active trading or monitoring to decide when its time to sell and what to buy next.
3. What About Physical?
The majority of commodity investments are meant for traders, but there are a select few products that are designed specifically for buy and hold investors and their long-term portfolios. The author utilizes the last section of his article to cite the hellacious contango that a number of futures-based ETFs can exhibit. Again, an investor buying and holding (without keeping a close watch) a futures-based product simply does not fully understand what he/she is holding, and is making a fatal error. Though these ETPs come as an equity ticker, they need to be thought of as a futures product and as such should be traded accordingly [see also Three Ways To Play $2,000 Gold].
During this latter segment of the article, the option of physically-backed ETFs or even physical commodities is entirely overlooked. Physical products are intended to reflect the performance of the underlying commodity by simply holding something like silver in a London vault. These products are something of a rarity, because that can be effectively used in a long term portfolio and even for retirement purposes without careful monitoring. To prove this claim, let’s take a look at the trailing five year returns of SPDR Gold Trust (GLD) and iShares Silver Trust (SLV), two ETFs that invest in physical gold and silver respectively. GLD has brought gains of 184%, while SLV saw a boost of 172%, dwarfing the 12% loss in the S&P 500.
When it comes to bullion, you would be hard pressed to convince someone that the last ten years has been a terrible time to hold something like gold or silver. In 2000, and ounce of gold went for less than $500/oz. but is now trading for over $1,600/oz. Tripling your money in 10 years certainly isn’t an everyday feat and the power of these physical products and commodities should not be overlooked [see also Dividend Special: Top Companies In Every Major Commodity Sector].
The WSJ aimed to make a case against commodities, which it effectively completed. However, it left out a number of key points and factors that should be considered by all investors. For 95% of commodity investments, if you are not an active trader or have vast knowledge of the underlying asset, the security is probably not meant for you. But traders and complex investors have been generating astounding returns in the commodity world in the past (see Jim Rogers), and they will continue to do so for years to come [see also The Guide To The Biggest Companies In Every Major Commodity Sector].
Disclosure: No positions at time of writing.