HardAssetsInvestor.com [HAI]: We have seen new types of funds, particularly exchange-traded funds [ETFs], open up the commodities markets to new investors. Is that a good thing? And are you using commodities more in your clients’ portfolios?
Roger Nusbaum (Nusbaum): My take on the big picture is this: Basically, the fact that there are more choices is fantastic. I do, however, view all these new products as an opportunity for people to start doing stuff with something they know very little about, and either compromise their returns or take on a lot more risk than they realize. The unknowable is whether all these new investors realize the consequences of their decisions.
HAI: So how should commodities be used?
Nusbaum: I really go out of my way at every turn to preach moderation with commodities. They are a great tool that can serve one or two or three purposes depending on someone’s sophistication level. You’ll read things about how you should 20% or 25% of your money in commodities. The “money mangers” saying this don’t realize the kind of volatility that 15 percent or 20 percent commodities introduces to a portfolio.
The people I manage money for just want to have enough money when they need it without having too many knuckle white rides along the way. Commodities can be a good tool, but if used incorrectly, they can increase the white-knuckle experience.
HAI: What do you see as the key benefits of a commodities position?
Nusbaum: The primary reason I use commodities exposure is diversification. Every account I manage, for instance, has exposure to gold. I use the [the streetTRACKS GoldShares] ETF (GLD).
My premise is simple: when things get nasty—by which I mean, when there is an external shock—I expect that gold will go up. That’s what the track record shows.
HAI: We’ve seen the correlation between gold and the broader stock market tighten recently—witness what happened in February. Is the gold case still true?
Nusbaum: I don’t consider what happened to the market in February to be a “nasty external shock,” so I am not surprised that gold didn’t go up there. I don’t think it takes away from the gold case. Things like 9/11 are nasty external shocks, and the government seems insistent on telling us that that sort of thing will happen again. I have a modest weight in the portfolios: 3%-ish. That’s just one little piece that I suspect will do well if we have a nasty external shock and the market heads painfully lower.
For now, I have faith. If something horrible happens and gold doesn’t do the trick, I’ve got a whole lot more learning to do.
HAI: What other commodities do you include—or are considering including—in client portfolios?
Nusbaum: I’m favorably disposed to the concept of agriculture: food or softs exposure. I can envision, with gold at 3% in a portfolio, accessing a food commodity in one way or another for another 2%. That would be 5%, and that’s about where I want to go.
I personally own the [the PowerShares DB Agriculture ETF] (DBA). I bought it as a litmus test to get a first-hand feel for how it trades, I traded it once—it’s been pretty volatile. I sold it, and then bought back in. I want to see how it behaves for a few months before I decide that it is a product I want to buy for clients.
Going forward, I would expect that there will be more choices along these lines. I am not a fan of some of the broad-based products that are out there: with so much energy, so much food, etc. Invariably, I find myself not wanting exposure to oil, because it is simply too volatile. It is difficult for me to incorporate oil into retail portfolio, so I have zero interest in the broad-based fund. I like the idea of going narrower: it’s easier to follow the gold market or the wheat market than to be on top of all 154 commodities markets.
HAI: What about base metals?
Nusbaum: In base meals, my clients own a stock—either CVRD or Anglo-American. Generally speaking, I think the space of industrial metals is crucial, and accessing it is very important for a diversified portfolio. But quite simply, I prefer stocks. I am an equity manager, as opposed to a commodity pool operator. Generally, for my clients, stocks are also easier to understand.
Another example is copper. I recently sold—and will probably buy back in soon—one of the Chilean banks. Chile is an old story, but a good one. The economy does very well when things are good well for copper. So the bank is a beneficiary of the copper boom, but it also pays a big fat dividend, and it is probably less volatile than the metal itself.
HAI: How do you about the futures vs. bullion vs. equities question, as it pertains to gold?
Nusbaum: I am following [the new gold futures ETF from Powershares] (DGL) to see how it trades. When something new comes out, I like to give it six months or a year to prove itself out
The idea with gold is that, most of the time, I expect it to do very little. The possibility of capturing, say, 95 percent of the effect of gold … but having 4% in extra interest … could be nice. If DGL does turn out to be a good proxy for the price of gold, I suspect I will make a switch toward the end of the year.
HAI: Are there concerns about contango, and about how few people understand the term?
Nusbaum: When we last talked, I said about the oil ETF that understanding contango would not be so important as long as the fund was capturing the effect. That belied a less-than-thorough understanding of the magnitude of contago when that product first launched, which is just one of the reasons I have not accessed oil for clients. I did not expect the oil products to behave in the manner that they have.
The short answer is this: I know from talking to people and from the comments left on my blog that a lot of people managing money do not understand contango. In fact, I don’t think they have even an elementary level of comprehension about this entire [commodities] market. It is clear from the kinds of things they are asking about and the manner that they are using these products that they just don’t understand.
It is crucial for people who are going to swim in these markets to understand what they are doing and how the commodities market operates.
HAI: What else should investors be concerned about regarding commodities?
Nusbaum: The most important thing to me about accessing this space is to understand that commodities are a tool to reduce overall volatility. For people who are not looking for “action” out of their accounts, it is a great way to reduce volatility: to have something that zigs when stocks zag. But as you go heavier and heavier into the space in terms of exposure, commodities change from a diversification tool to something that ultimately increases the volatility of the portfolio. That’s critical to understand. Gold went form $720/ounce to $590/ounce in what seemed like ten minutes last year, and it is capable of making big and fast moves in other direction. If you have a modest position, the result of being on the wrong side is limited; if you have a 20% position, you’ve dug yourself a three-year hole.