Commodities from an Investment Strategy Perspective
Financial Market Commodities Are Not Usually Physical Assets
All right. So today wanted to jump on and talk about commodity investments which we’ve not covered yet in our Weekly Perspectives Video series. So, talk about what they are and how we think about them from an investment strategy perspective. So, first thing to note, since we’re talking about financial markets, we’re generally not talking about physical possession of commodities, because that involves storage, is not practically an investment strategy approach that most folks can pull off. So, we’re talking about the way financial markets allow for access to commodities which would be through what are known as commodity futures contracts which we won’t go deep on today, but are basically derivative investments that give away to give somewhat direct exposure to the underlying commodity or basket of commodities, and that’s the most common form of investment that you’ll see in commodities out in the marketplace, a lot of mutual funds that are implementing commodities via that type of strategy.
Investment Characteristics for Commodities
So, let’s talk about the investment characteristics for commodities. So, first thing to note, even if we’re talking about a broad basket of commodities across industrial metals, precious metals, livestock, oil, energy, it still tends to be a very, very volatile investment. So, you’ll see big swings in the value of commodities from year to year, depending upon what’s going on with inflation or the broader economy. And of course, that volatility is even higher if we were talking about most individual commodity investments.
Commodities Are Considered an Alternative Strategy
So, we also think of commodities as an alternative strategy because they do tend to be somewhat unrelated to the performance of the broad stock and bond market. Of course, like everything, that’s not true in every single year. But if you look at over the long-term, commodities, I do think fit best within that alternative investment category. Because of those first two points, though, you can see commodities either outperform or underperform those other two parts of the market stocks and bonds for very, very long periods of time. So that’s something that long-term investors need to keep in mind. If they allocate to commodities, you can have these long periods of outperformance, which, of course, makes it pretty easy to stick with, but also periods of extended underperformance, like we saw in the late nineties and portions of the early 2000s that can make sticking to commodities challenging.
A Strategy to Hedge Against Inflation
So the most positive thing I think you can say about commodities is they are one of, I think, just two asset classes that tend to do well when we get a big uptick in inflation relative to what the market was expecting. And of course we saw that here relatively recently, commodities and inflation-protected treasuries which we’ve talked about in the past, are really the only two strategies that reliably tend to do well in that type of environment. So that’s a good segway into thinking about who might consider owning a commodity.
Are Commodities the Right Investment for You?
So first would be those folks that are looking for very broad inflation protection in their portfolio that they can’t get through inflation-protected securities that might be one type of investor where they could make sense. But in general, with the way the alternative investment marketplace has developed, we generally don’t think commodities make sense except for those investors that have very very large allocations to alternative investments, and you might want to have commodities as one sleeve of that potential allocation. If you have no allocation alternatives or relatively low allocation alternatives, commodities might not be the best way to go. So hopefully that’s helpful in terms of sharing some perspective in terms of what commodity investments are, how you go about accessing them, what we think about the investment characteristics and how they might fit in the portfolio. If you have other questions you’d like for us to tackle, feel free to reach out to your advisor and suggest those questions, or click the link below and submit questions in that way.
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Jared Kizer, CFA
Head of Investment Research
Jared Kizer evaluates findings from academic research and applies that learning to develop investment strategy recommendations. Jared collaborates daily with advisors and clients, helping investors better understand the complicated concepts that can have a tangible effect on their financial lives. Jared holds a master’s degree in finance from Washington University in St. Louis.