Investing In Commodities
I was reading Larry Swedroe’s The Only Guide to Alternative Investments You’ll Ever Need the other day, I have been thinking about adding commodities to my portfolio since. No, I am not going to buy a futures contract; however, I have been thinking about adding commodities to my overall portfolio. Commodities have been taking significant hit this year as evident by QRAAX (represents the S&P GSCI index) and by PCRIX (represents the DJ-AIGCI index).
What Are Commodities
Commodities comprise a broad category of raw materials used by industry and traded on specialist commodities markets that include energy (e.g., natural gas and oil-related commodities), industrial metals (e.g., copper, aluminum, lead, nickel, and zinc), precious metal (e.g., gold and silver), agriculture (e.g., wheat, corn, soybeans, cotton, sugar, coffee, and cocoa), and livestock (e.g., cattle and hogs).
Why Should You Invest In Commodities
Commodities are a source of inflation and thus provide a strong hedge against inflation. Commodities also convey substantial diversification benefits due to its negative correlations to both stocks and bonds. In short, adding a small amount of commodities, say 5%, can improve your overall portfolio in several ways; specifically, better overall performance due to diversification benefits and lower risks.
How To Invest In Commodities
There are several ways to gain exposure to commodities without the complexities of futures trading. As mentioned earlier there are mutual funds, such as QRAAX and PCRIX that tracks the S&P GSCI and DJ-AIGCI, respectively. Unfortunately, QRAAX has a fairly steep expense ratio of 1.37% and PCRIX has a prohibitive minimum initial investment figure. Other options include commodity-related Exchange-Traded Funds (ETFs) and Exchange-Traded Notes (ETNs). Here are a few that’s worth looking into:
- GSG – iShares S&P GSCI Commodity-Indexed (ETF)
- DJP – Dow Jones-AIG Commodity Index Total Return (ETN)
Here’s a comprehensive list of commodity ETFs and ETNs.
Obviously, investing in commodities is not without risk and it’s not atypical for commodities to underperform for an extended period of time. Additionally, as you diversify your portfolio, it will become harder to track your performance against standards like the S&P 500, which may add a new level of anxiety.
Do you currently invest in commodities? Could you share your thought with us?
This article was featured in the Carnival of Personal Finance #185 at the Fraud Files blog.
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inflation, DJ-AIGCI, S&P GSCI, Exchange-Traded Fund, Correlation, Futures Contract, Commodities, diversification, Expense Ratio, ETFRecommended articles
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No I haven’t heard or know anyone that has invested in commodities.
Thanks for teaching me something new and giving me something to discover and learn.
I trade commodities, or commodity related stocks, on a regular basis. This year saw amazing volatility in previously ultra boring areas of the economy (e.g. coal, corn, etc), so buying the ETFs with a good stop loss order to protect yourself from a freak sell off is the way to go — for me at least. The main danger lies with the weekly inventory reports where a shortage can result in a big up move, or a glut can cause down move in a matter of seconds. Especially in oil or nat gas.
I’ve been following the natural gas market (via the UNG) for a few days now waiting for a chance to get in. Dennis Gartman (bigtime commodities expert) said if he had to buy one commodity last week, it would be grain. The GRU would probably be the best method to buy grain for average investors.
FYI. I’ve used Managed Futures for a portion of some of my clients portfolios. As of the end of November, that portion of our portfolio is up just over 19%. It’s nice because we actually have something positive to talk about during this horrible year.
If you have to be ready to handle volatility if you are going to invest in these type of investments. Although, they can reduce the overall risk of the portfolio, that doesn’t mean they reduce volatility.
Up until a few months ago investing in oil would have been a gold mine. I hear alot about commodities and they seem more of a blue chip to invest in over the long run. Do you think this is true? Maybe I should think about putting money into a commodities mutual fund.
@Craig – I think this is a terrific time to buy oil. In any case, investing in commodities is not like investing in U.S. large cap stocks; and in my opinion should not replace it. Personally, I am planning to add about 5% position in commodities either via an index fund or ETF (but I still have to do some more reasearch). Also, I am not planning to buy specific commodities, but looking for something that track the overall commodities market.
@pinyo that never hit me to buy in oil right now. You have to imagine within 5 years the prices will be over $3.00 again. Tracking overall commodities market would make sense in a more long term strategy. For me, I am brand new to this and investing in general, trying to learn the basics. Seems like even buying individual commodities is less of a risk than individual stocks right now.
@Craig – Commodities is extremely volatile even compared to this year stock market. Just take a look at the two charts above. Do you see that in both cases commodities price went up higher than the S&P500 and dropped well below the S&P 500? That’s volatility.
@pinyo That’s a good point. I guess nothing is real safe, especially these days.
I was actually thinking of getting into some oil stocks (dividends + play on oil) or possibly an oil ETF. I can’t believe oil will remain where it is over the long run as it is a finite resource.
Commodities investing requires a lot of skills. So, if you don’t want to through your money away, you must study carefully first. Thanks for your post! It really makes sense for all beginners .
Pinyo,
Have you jumped into the commodities sector yet? If so, where did you choose to invest? If not, I hope you blog about the experience and end result.
@Start-up — No, I haven’t yet — I am still trying to clean up some credit card debt and max out my 2008 Roth. Once I have money to invest, I’ll probably start off with GSG or DJP, unless I can find something less expensive.
If I could throw out a decent idea… there are hydrocarbon based trusts/MLPs that are paying high yield dividends in the 8-20% range. Not to mention, if oil goes back up (which it probably will), you also get the equity appreciation.
The risk is fairly high compared to a full fledged index fund, but if you buy on the huge pullbacks in oil, and set your stop loss orders, you should be OK.
PBT and NGT are good examples if anyone is curious.
You must realize that commodities are a natural hedge against inflation and unfortunately for commodity traders we have been in a deflationary market environment the past few months. However, I think it’s a necessary addition to your asset allocation due to it’s low correlation with equities and I suspect we will see a period of increased inflation over the next few years. Once credit conditions improve we’re likely to see the kind of inflation we saw in the late 70’s under Volker.
From a technical analysis perspective commodities are probably not at their bottom just yet but for the long term investor it’s probably a great time to buy low which is always the best time to buy. Just remember to take your profits by rebalancing your portfolio on quarterly basis because you never know how this Fed is going to act.