By Suzanne McGee
Gold prices are hovering near 52-week highs, propelled upward by
speculation that Federal Reserve policy makers will cut interest
rates. Swine flu is wreaking havoc in China, the world's largest
pork producer, boosting prices for lean-hog futures. Corn and other
agricultural commodities are trading at or near their three-year
highs, thanks to cool, rainy weather in the U.S. and floods that
have delayed planting and raised fears of meager harvests.
Trends like these encouraged Citigroup's commodities research
team to publish a detailed, upbeat 158-page analysis in April,
"Springtime for Commodities." The Citi team declares that there's a
"sunnier picture ahead" even for some kinds of energy commodities,
like U.S. natural gas, which has been in the doldrums for several
months.
Does this mean it's a great time to diversify your portfolio to
include a commodities-related fund, especially as the number of new
products in this sector continues to grow?
Possibly -- but be wary of the myriad claims the fierce
proponents of commodities investing make when supporting their
favorite asset class. Some of those claims may be true, but others
are little more than myths.
MYTH 1: Commodities are an asset class, in the same way that
stocks and bonds are, and should automatically be included in your
long-term asset allocation.
Plenty of academic studies support the first part of this
statement: Commodities possess most characteristics of an asset
class, offering distinctive return patterns that often zig when
other markets zag. A proliferation of new index-based products
continues to make commodities even more liquid and investible with
every year that passes.
But unlike stocks and bonds, commodities don't generate
earnings, produce dividends or deliver interest income. Instead, to
make money, you need a supply/demand imbalance to materialize in
one or many different markets (corn, wheat, coffee, copper, etc.).
That kind of imbalance, as well as its impact on prices, is
notoriously difficult to predict, and often produces significant
volatility that can unnerve investors. Also, many commodity funds
levy higher expense ratios and/or other fees than their stock or
bond counterparts.
"We would think of commodities as an opportunistic asset;
sometimes you are in and sometimes you are out of them, depending
on the outlook for specific commodities," says Scott Opsal,
director of research at Leuthold Group, an independent
market-research firm in Minneapolis. "They just aren't a
buy-and-hold kind of asset class."
MYTH 2: Commodities are a reliable hedge against inflation.
Commodities can act as an inflation hedge, but it's far from
certain that they will. A Vanguard Group research report published
last year concluded that commodities, at best, are "inflation
sensitive": They can generate big returns for investors when
inflation isn't anticipated and arrives unexpectedly. Otherwise,
it's a bit of a crapshoot.
There's a reason Vanguard will include Treasury
inflation-protected securities, or TIPS -- bonds structured so that
their value rises along with inflation -- in the Vanguard Commodity
Strategy Fund it plans to roll out this month: TIPS are correlated
more closely than commodities with both anticipated and unexpected
inflation. Over the longest time horizons, Vanguard said in its
most recent commodities research published in May, stocks fare
better against inflation and "may be the ultimate protection"
against rising prices.
Gold bugs are still big advocates of hanging on to bullion as a
way to shield yourself from inflation shocks. Alex Bryan, director
of passive-strategies research for North America at Morningstar
Inc., disagrees. "You can fare better with stocks or bonds,
including TIPS, as inflation hedges. And they are less risky and
volatile" than a fund based on gold or commodities, he says. (Data
going back decades show that stocks are a better inflation hedge
than gold, at least over periods of more than a year or two.
MYTH 3: If you invest in a commodity fund, you're getting direct
exposure to the commodity itself.
In a handful of cases, like SPDR Gold Shares ETF (GLD), that may
be true. Because GLD invests in gold bullion, its price will track
spot gold or gold futures more closely than many other products.
But it gets too complex and costly for ETF providers to maintain
warehouses full of grain, copper or coffee beans, much less a big
stockpile of crude oil or a storage facility full of natural gas.
That explains why, for instance, if you want energy exposure,
you're likely to end up owning ETFs either structured as a
commodity pool -- like U.S. Oil (USO) -- that invests in futures
contracts to track a natural-gas, crude-oil or other index, or a
fund that invests in stocks to track the share prices of 150 or
more energy-producing companies, like Vanguard Energy ETF (VDE).
Opting for the latter means you are adding business risk to the
commodity-price risk.
When you do obtain exposure to a commodity or basket of them via
futures contracts, the structure of the funds means it's still not
a pure play. That's because managers use some of the fund's assets
to buy Treasury bills to post collateral for those futures
contracts (which are pledges to deliver or to purchase a commodity
at a fixed price on a future date). "A big part of the return from
commodity futures is actually from the collateral invested in
T-bills," says Morningstar's Mr. Bryan. Now that T-bill returns are
low, he says this is one of the reasons existing investors can find
their fund's performance underwhelming and the gap between their
own returns and the performance of the underlying commodity
sizable.
MYTH 4: Most broad-based commodity index funds will deliver
similar returns.
"I'll have new clients tell me that they're investing in
commodities, but without more detail, that's about as useful as
them saying, 'I own fixed-income investments' without explaining
how it's broken down between Treasury bonds, munis or high-yield
[junk bond] securities," says Ryan Marshall, a partner at Ela
Financial in Wyckoff, N.J.
There are gold indexes and energy indexes. There are narrow
indexes and broad, widely diversified benchmarks. And the weighting
of different components can vary. For instance, the S&P Goldman
Sachs Commodity Index (a diverse index that emphasizes the economic
importance of each product) can end up looking like an energy
index, with two-thirds or more of the commodities exposure based on
what happens to crude oil, natural gas and related products. At the
other end of the spectrum, the Bloomberg Commodity Index consists
of 22 different products in seven sectors; no sector can account
for more than a third of the index at any time. Then there's the
Deutsche Bank commodities index, which emphasizes liquidity: Its
six components are the most heavily traded commodities futures
contracts in existence.
Even apparently analogous funds can deliver different results.
Consider two energy funds, both of which employ crude-oil and
natural-gas futures contracts. One may concentrate on short-term
contracts, while the other uses futures dated as much as 12 months
in the future. Historically, three-month futures and 12-month
contracts have quite different prices, and the resulting price
curve can vary significantly over time, producing different results
even if spot energy prices trend higher.
Then, too, if you invest in a broad commodities fund that
happens to overweight the one commodity that's doing poorly while
others thrive, you'll inevitably be disappointed when you compare
your returns to those for commodities as a whole. That's why Mr.
Opsal advocates focusing on commodity subgroups that investors
believe are likely to outperform in the shorter to medium term,
rather than taking a broad approach. "If you're investing in
commodities because you think this year's harvests will disappoint,
you want to be paid for that" if you are right, instead of having
lackluster returns on energy and metals offset your profits in a
diverse fund, he says.
MYTH 5: Commodities aren't speculative in nature.
Actually, few asset classes are more speculative, unless you
decide that bitcoin is an asset class. "They are guaranteed to be
unpredictable," says Ashley Folkes, Phoenix-based senior vice
president of investments for wealth-management firm Moors &
Cabot of Boston.
That's because you're simply betting on the price or prices of
one or several commodities, which can move violently in response to
news events about supply and demand -- or might not react at
all.
Some advisers think this is still a worthwhile activity, whether
it's labeled a speculative, short-term investment or a long-term
core holding. "For some clients, it's a great way to diversify,"
says Mr. Folkes, noting how commodities can move opposite to other
asset classes. And it's an approach that makes sense to his clients
once he explains that they're investing in the price movements of
products that they eat or otherwise consume every day -- this
demystifies commodities as an investment concept, he says.
Others focus on the recent underwhelming results from investing
in commodities as one reason for investors to consider alternatives
in pursuit of their portfolio strategies. "If the asset I'm using
as a diversifier is one that has zero or little long-term growth
prospects, and it's a volatile asset, I would much rather add a
municipal bond fund" to play that role, argues Ian Weinberg, chief
executive of Family Wealth & Pension Management in Woodbury,
N.Y.
Ms. McGee, a former commodities reporter for The Wall Street
Journal, is a writer in New England. She can be reached at
reports@wsj.com.
(END) Dow Jones Newswires
June 09, 2019 22:27 ET (02:27 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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