Can Commodities Mount a Comeback?
MFQ | SATURDAY, JANUARY 7, 2012
This asset class has had
a leading role in many portfolios in recent years, but
turned in a dreadful performance late last year. Do
these investments merit another audition for a fund
investors who raced after popular commodities last year
discovered how mercurial these markets can be. Big price
swings in 2011 left many fans badly disappointed. Even
gold, normally viewed as a haven in troubled times,
turned in an uneven performance. It rose about 11% if
you held it for all of 2011, but that's little comfort
to those who bought near its nominal all-time Nymex
high of $1,923.70 in September. From that peak, prices
ended 2011 down about 19%.
weren't the only investors feeling burned. The Dow Jones-UBS
Commodity Index fell 13.37%, dragged down by natural
gas (-47.1%), wheat (-34%) and cocoa (-32.4%). There
were lots of reasons for the first-half rally's swan-dive,
but fears about China's slowing economy as well as Europe's
sovereign-debt woes were the most prominent.
do commodities deserve another shot? We don't think
they should have a starring role in your portfolio early
in the year, but they do deserve a supporting part.
And investors could have a chance to buy commodity-related
funds and stocks at lower prices in coming months if
some of the recent global worries persist. In any event,
commodities should be included in any portfolio to provide
RESEARCH DONE IN 2005
by professors K. Geert Rouwenhorst and Gary Gorton
of the Yale School of Management shows that fully
collateralized commodity futures historically
offered the same risk-adjusted performance as
equities and usually trade in a different direction
from both stocks and bonds, offering a good hedge.
Despite commodities' short-term volatility, market
watchers say rising long-term demand for raw materials
from the emerging markets' growing middle class
should keep their prices on a general uptrend.
There are different ways to get commodities exposure
without having to lug the physical goods home. Much
depends on how active or passive an investor wants to
be. The traditional way is to trade futures, and they
still offer a quick and liquid means of making short-term
bets. But futures are strictly for the very active,
disciplined trader, says agriculture-commodities advisor
Shawn Hackett, president and CEO of Hackett Financial
Advisors. "You can't put a futures contract in
a drawer and forget about it like you can with an ETF
or a stock," he says. Hedge funds and commodity-trading
advisors are another alternative, but their investment
minimums can put them out of reach of most investors.
MUTUAL AND EXCHANGE-TRADED FUNDS are
by far the easiest to understand and can be held for
any duration without direct action on the part of the
investor. These funds may deal in the futures markets,
but the shareholder needn't worry about the intricacies
of direct investment or approaching expiration dates.
A broad-based exposure helps reduce volatility and
ensures the portfolio benefits from price movements,
as commodities don't often affect one another. "Commodities
are totally distinguishable," says Abraham Bailin,
exchange-traded fund analyst at Morningstar, citing,
for example, how Russian wildfires in the summer of
2010 lifted wheat prices, but didn't have any effect
on crude oil.
Commodity ETFs offer one way to get wide exposure,
though they have received some bad press because of
a real issue called negative-roll yield.
The negative-roll yields result from the market's structure,
which reflects both the price of current and future
supplies. Prices of contracts closest to the present
month are usually lower than contracts reflecting what
prices could be a year from now. Prices for those longer-dated
contracts are usually higher to account for expenses
such as the cost of storing and insuring the commodity
over time. That higher, future cost is known as carry,
ETFs based only on nearby prices lose money if a market
is in contango because they have to buy the higher-priced,
longer-dated contract and sell the cheaper spot month.
So they are selling low and buying high. When current
prices are above later-dated values, in a condition
known as backwardation, the fund benefits by selling
high and buying low.
A number of commodity-related ETFs and mutual funds
are trying to limit the drag caused by negative-roll
yields, say Bailin and Kathryn Young, Morningstar's
Among commodity ETFs, Bailin likes the PowerShares
DB Commodity Index (ticker: DBC), which tracks
the Dow Jones-UBS index. Using an algorithm and staying
slightly further out on the commodity price curve—three
to six months versus the spot price—minimizes the roll
yield as prices between these months tend to be more
Bailin also favors the U.S. Commodity
Index ETF (USCI), which is based on the research
of Yale's Rouwenhorst. Each month the index selects
14 out of 27 commodity futures on the basis of the highest
level of backwardation and annual price change. The
idea is that higher current prices are forecasting that
present supplies on hand will be insufficient to meet
future demand and thus make the prospect of higher prices
Young says the Pimco Commodity
Real Return (PCRDX) also follows the DJ-UBS index,
but is actively managed to help minimize the effect
of roll yield. It has a long, solid track record, and
she likes that the fund uses some of its money to invest
in several bond funds to lower risk, with much of the
cash in inflation-protected securities, known as Tips.
Her pure-play commodity mutual fund pick is Pimco
CommoditiesPlus Strategy (PCLDX), which tracks
the Credit Suisse Commodity Index.
John Person, president of National Futures.com and
co-author of the Commodity Trader's Almanac, suggests
that retail investors devote anywhere from 5% to 15%
of their portfolio to commodities, depending on their
risk tolerance. For someone who wants to earmark 15%
to resources, he recommends 5% in the SPDR
Gold Trust (GLD), 5% in agriculture and 5% in
energy, which can be made up of commodity stocks.
In agricultural stocks, he likes meat producers Smithfield
(SFD) and Tyson (TSN),
noting a drought in livestock-producing areas has cut
herds, which should result in higher meat prices in
To reach his proposed allocation in energy, Person
favors Market Vectors Oil Services
ETF (OIH) as a way to buy the oil-services index.
Because oil prices already are high, there's substantial
demand for more productivity, which should bolster the
group, he says. If natural-gas prices continue to fall,
the U.S. Natural Gas Fund ETF
(UNG) could be a good value, especially if the natural-gas
futures contract falls near $2.80 per million BTUs,
where he would buy "aggressively." More coal-fired
power plants are switching to gas because of new Environmental
Protection Agency rules.
Keep in mind that buying commodity stocks isn't the
same thing as owning the actual commodity. At the very
least, commodity stocks are going to be more influenced
by the equity market and may not reflect the short-term
circumstances within the physical market, say Bailin
and Person. For instance, gold mining stocks have at
various times in recent years far outperformed the price
of gold because their profitability improves very sharply
once they reach breakeven.
Agriculture-commodities advisor Hackett says hard assets
can have a place in a retail portfolio, but only if
the investor understands the high risk/high volatility
nature of commodities. "The job as an investor,
as a user, as a producer is to know when to sell and
when to buy." He dislikes commodity ETFs, suggesting
instead that investors target agriculture companies
with production and infrastructure capacity. He likes
Cresud (CRESY), a South
American farmland trust, and Alliance
Grain Traders (AGT.Canada), a Canadian agriculture
Cresud makes it easy for someone to own farmland without
having to buy actual dirt, while he sees Alliance Grain
Traders as a strong niche player in the "pulses"
market—protein crops like lentils and chickpeas. It's
a way to play the growing global demand for food. "These
crops are too small for the big ag firms to care about,
and the firm knows the buy and sell sides of the business,"
MANY ADVISORS CAUTION against jumping
into commodities in a big way until the conditions that
caused the drop in late 2011, like Europe's debt problems,
begin to subside. And some markets, like cotton, sugar
and cocoa, are still suffering from oversupply. As Hackett
puts it, "Now is a good time to get ready to buy
as the trends are down."
The second half looks more promising as an entry point,
since prices could come down a little further and commodities
often herald an economic rebound, possibly in 2013.
That would put commodities back on center stage.