We are making two changes in our model portfolios this week.
First, we are going to take advantage of the recent sharp correction in commodity prices to add to all portfolios a 3% position in the iPath Dow Jones-AIG Commodity exchange-traded note (NYSEARCA:DJP). After reaching a 52-week high of $73.15 on July 2, DJP has dropped 21% to $57.85.
The commodity sector reached extremely overbought conditions in the second quarter of 2008 and was due for a signficant intermediate-term correction. Oil in particular was very extended, having doubled in a year's time, and was the last commodity to peak in price. In less than a month, oil has fallen from $147 to $115 per barrel, which has assisted the relief rally in the stock market. The energy sub-sector of the commodity markets is still showing double-digit year-to-date returns, but the other major commodity sectors - agriculture and metals - have given back all of the strong gains made in the first quarter of 2008. DJP's price is back to where it started the year.
We view the retreat in commodity prices as a normal correction in an ongoing bull market. The bullish longer-term case for hard assets, centered on increasing demand from the developing economies of the world and inflationary monetary policies from global central banks, remains very much intact. Accordingly, we think that for a diversified fund such as DJP, most of the price correction has likely already occurred. In addition to providing what we think will be an attractive return, DJP offers attractive diversification benefits because it is completely uncorrelated to broad stock and bond indexes.
The principal risks associated with DJP are (1) the global economic slowdown is more severe than what is currently discounted in financial markets; (2) major global central banks move to tighten monetary policy in a significant way; and (3) the U.S. dollar is experiencing more than an oversold bounce and is about to embark on a strong upward advance. We think the first risk is probably the most significant, and that the probabilities are skewed against the second and third risks.
Relative to other broad based commodity funds, DJP appears better positioned to weather a more serious global economic slowdown because it has a comparatively smaller allocation to economically sensitive commodities and a larger allocation to non-cyclical commodity sectors (e.g. agriculture) and monetary commodities (e.g. gold and silver). For example, DJP has only a 21% allocation to crude oil and its derivatives (heating oil and unleaded gas), which is significantly less than other commodity indexes/funds.
The components of DJP and their respective weightings can be viewed here.
The fund has $3 billion of assets and carries an expense ratio of 0.75%.
The second change we are making to our portfolios is to replace our 3% position in the PowerShares Clean Energy ETF (NYSE:PBW) with a 3% position in the PowerShares Global Clean Energy ETF (NYSE:PBD).
In the emerging alternative energy sector, it is important to be as diversified as possible. Although PBW and PBD are highly correlated, PBD offers better diversification on multiple fronts: (1) larger number of holdings; (2) greater market cap coverage; (3) more globally diversified, which is important in the case of alternative energy because a number of the leading companies in the sector, and especially in the wind-power industry, are domiciled overseas.