Why Retirees And Near-Retirees Should Not Buy Commodities

| About: The United (USO)
This article is now exclusive for PRO subscribers.

Summary

The increasing expectations for inflation after the elections and the strength of oil after the deal of OPEC have led many investors to buy commodities.

However, retirees and near-retirees should definitely avoid buying commodities.

The article analyzes why these investors should not attempt to buy commodities.

Since the elections, expectations for future inflation have greatly increased thanks to the pledge of the president-elect to spend large amounts on infrastructure and boost the economy in several ways. This has led some investors to consider initiating long position in commodities, such as the United States Oil (NYSEARCA:USO) and SPDR Gold Shares (NYSEARCA:GLD). Oil has also exhibited remarkable strength since OPEC achieved a meaningful deal three weeks ago. However, in this article, I will analyze why retirees and near-retirees should avoid buying commodities.

First of all, it has proven almost impossible, even for the best economists, to predict inflation. The unprecedented amounts spent in the three QE programs led many experts to believe that inflation would markedly increase, but all these experts were proven wrong. In addition, expectations for high inflation drove the rally of gold to its all-time high of $1,900 in 2011, but gold has plunged 40% since then. Such a loss would be devastating even for the wealthiest retirees. Therefore, investors should not attempt to forecast future inflation, as this is an almost impossible task even for the greatest economists.

Investors should also note that commodities do not distribute a dividend and hence there is no income stream from these securities. As retirees definitely need an income stream, which should be as reliable as possible, the absence of a steady income stream in commodities renders them totally inappropriate for people near retirement. These people should only focus on stocks, which offer a dividend, and bonds, which offer a steady interest income.

Even worse, commodities are usually characterized by a contango structure. This means that the distant futures are usually more expensive than the prompt futures and hence investors should pay the difference every month in order to roll over their positions from one month to the next. Even if investors choose to purchase a commodity ETF instead of futures, such as the above-mentioned ETFs, these ETFs lose value every month due to the contango structure. This eroding factor is paramount and should never be underestimated by investors. To be sure, the spot price of oil has rallied approximately 50% during the last 12 months whereas USO has gained only 8% during that period. It is also worth noting that the magnitude of contango tends to be much more pronounced when the commodity is in a downtrend. Therefore, as near-retirees and retirees definitely do not want time to work against them to such a great extent, they should certainly avoid buying commodities.

Moreover, investors should never initiate positions in a security if they cannot handle a considerable period of paper losses. If a commodity temporarily declines, retirees are not likely to be able to wait for a rebound. As mentioned above, time usually erodes the value of commodity ETFs due to their contango structure and hence a temporary decline in the spot price is accentuated by the eroding effect of time. Consequently, retirees cannot wait for a rebound, as a prolonged decline will make them lose their sleep. Therefore, they are likely to close their commodity positions at a loss in the event of a temporary decline, which is never a promising strategy. This is actually a rule for all investors, not just retirees; if they cannot stomach a prolonged period of a downtrend, they should never initiate a position in the first place. At least stocks and bonds offer a dividend and interest income, respectively, so they render waiting for a turnaround somewhat easier.

To sum up, retirees and near-retirees should avoid initiating long positions in commodities, as these securities have many features that are totally incompatible with the goals of these people. First of all, unlike stocks and bonds, commodities do not offer a steady income stream. In addition, they usually have a contango structure, which markedly erodes the value of these securities over time. Hence if a commodity temporarily declines, it is really hard for investors to retrieve their losses. All in all, retirees should definitely avoid any investment that has time working against it and hence they should only focus on stocks and bonds.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.