Commodities have been used in the past for their purported diversification benefit from their inherent low correlation to the total stock market, but do they really deliver?
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Commodities are materials like gold, oil, copper, livestock, agriculture, etc. Their value depends on their usage in production, and is directly related to supply and demand. Any position in commodities is therefore a bet on the short-term future, rather than long-term growth associated with stocks, bonds, real estate, etc. As such, investors have historically turned to commodities as a hedge against uncertainty.
Unfortunately, commodities themselves are unpredictable by their very nature. Crops go bad. The weather changes. Macroeconomic policies shift. Alternatives to things like copper are found. Ownership, storage, and transportation of commodities increase costs.
Stock ownership is a claim on a company’s future earnings. A bond is a contractual obligation between a lender and a borrower, with interest payments going from the latter to the former. Ownership of a commodity is not value-producing; it involves no earnings or cash flow and is simply a bet on production and/or consumption at that time.
Commodities are obviously useful to your everyday life, but not as an investment in securities markets. Think of owning a commodities fund as just paying for their storage somewhere. With technological advances, we would expect commodity prices to fall or stay flat over the long term. After fees (commodities funds are expensive; the popular PDBC costs 59 basis points), a commodities position is likely losing to inflation.
Essentially, even in inflationary environments, investors have historically been better off over the long term holding just about anything other than commodities. And we now have assets like REITs, TIPS, etc. as alternatives. Even a narrow gold fund should be a better choice than broad commodities. Commodities may offer a tiny diversification benefit to lower volatility and risk, but we still want our diversifiers to have positive future expected returns.
Andrew Tobias, in The Only Investment Guide You’ll Ever Need, maintains that “it is a fact that 90% of all people who play the commodities game get burned. I submit that you have now read all you ever need to read about commodities.”
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.