Commodities

From finiki
Jump to: navigation, search

In the original and simplified sense, commodities were things of value, of uniform quality, that were produced in large quantities by many different producers; the items from each different producer were considered equivalent. On a commodity exchange, it is the underlying standard stated in the contract that defines the commodity, not any quality inherent in a specific producer's product.[1]

One of the characteristics of a commodity good is that its price is determined as a function of its market as a whole. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, salt, sugar, coffee beans, soybeans, aluminum, copper, rice, wheat, gold, silver, palladium, and platinum.[1]

Commodities are generally regarded as an asset class for very knowledgeable investors using advanced portfolio strategies.

Commodities as an asset class

Arguments for

In a US context, the arguments in favour of investing in commodities, through mutual funds or ETFs (not futures), as part of a diversified portfolio of stocks and fixed income, are as follows: [2] [3] [4]

  • Over the long term, the returns of multi-commodity indexes are reported to be similar to that of stock market indexes
  • The volatility of multi-commodity indexes is supposed to be similar to that of stocks
  • Commodities have a low correlation with other asset classes so can be portfolio diversifiers
  • Commodities are a hedge against inflation

Arguments against

In a US context, the arguments against investing in commodities, through mutual funds or ETFs (not futures), as part of a diversified portfolio of stocks and fixed income, are as follows:

  • According to Rick Ferri, "there is no agreed upon way to measure the commodities market as an asset class. Commodity indices are primarily investment strategies that employ radically different weighting and rebalancing schemes."[5]
  • A study by the Bank for International Settlements found heightened correlations between commodity and equity prices from September 2008 continuing through 2012, because "the factors driving commodity prices have changed". Therefore, commodities may not be reducing the risk of stock-heavy portfolios anymore. [6]
  • The same study found that "Most if not all the returns from investing in commodities come from the (active) skill of the portfolio manager rather than the (passive) properties of commodity derivatives themselves." [6]

In a Canadian context, the Toronto Stock Exchange main index contains companies strongly influenced by the price of oil, natural gas, gold, base metals and so on, so investors having exposure to Canadian stocks may have no need to add any commodities to their portfolios.[7]

How to buy

Commodity futures

Commodities are traded on commodities exchanges around the world, often as futures. A futures contract is "a type of derivative instrument, or financial contract, in which two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price".[8] When transacting commodity futures, buyers and sellers can have two objectives: speculate on commodity prices, or hedge risk. Because there is a large amount of leverage involved, you can loose more than your original investment when buying a futures contract.[9]

Commodity funds

Investing in commodities can be done through funds of various types, including exchange-traded funds. These can cover single commodities, or commodity baskets.

References

  1. 1.0 1.1 Wikipedia, Commodity, viewed July 26, 2012.
  2. Frank Armstrong, Commodities as an asset class, July 2004, viewed December 22, 2015
  3. Larry Swedroe, Commodities can diversify risk, etf.com, May 15, 2014, viewed December 22, 2015
  4. Larry Swedroe, Commodities can hedge inflation, etf.com, August 12, 2015, viewed December 22, 2015
  5. Rick Ferri, Asset Class and Investment Strategy, November 27, 2014, viewed December 22, 2015
  6. 6.0 6.1 John Kemp, Don’t count on commodities for portfolio diversification, National Post, July 24, 2013, viewed December 22, 2015]
  7. Ram Balakrishnan, Should canadians add commodities to their portfolios?, Canadian Capitalist, July 18, 2010, viewed December 23, 2015
  8. Investopedia, Futures fundamentals: Introduction, viewed December 22, 2015
  9. Investopedia, Futures Fundamentals: Characteristics, viewed December 22, 2015

Further reading

External links

  • Commodity - Wikipedia
  • William J. Bernstein, On Stuff, September 2006: "In other words, the next time someone tries to sell you a commodities fund based on the Goldman Sachs Commodities Index, smile and say, "Sorry, but I’m from Earth and you’re from planet I Love Lucy. Let’s revisit this discussion in an alternate universe.""
  • The Great Commodities Debate Part I and Part II, Feb 13 and 14, 2008. An interview with Larry Swedroe and Rick Ferri on Seeking Alpha. Subscription required if viewed on more than one page. Disable your browser's javascript to view on a single page. Ferri: "...commodities fail the expected real return test. That's why I don't include them in portfolios. The lower expected returns of commodity funds are not a fair trade for the proven real returns of assets such as stocks. Low correlation is not, by itself, a good reason to do something. After all, stuffing money in a mattress has no correlation with stocks and bonds, but I don't recommend doing it."