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"...there is now an interesting change occurring in the industrial metals space… one of the most hated and disowned asset classes in the world. Despite all the negativity surrounding this asset class and the future of the Chinese economy, the base metals index is finally breaking out of its three year downtrend."
Commodities: To Buy Or Not To Buy ? 4/25/14: Christian Benthelsen WSJ Part 1
Commodity prices are on the rise, as gold, corn and other basic materials climb back from steep declines—and outpace U.S. stocks.
The rebound may stir hopes that a longer-term boom has resumed after three rough years for natural resources, and a measured bet could pay off.
But for ordinary investors, commodities often are a raw deal. They should take a hard look before loading up.
First, weigh whether you need the exposure. Perhaps the main reason investors hold commodities is to hedge against inflation. But inflation remains muted in the U.S. Moreover, many investors in broad-market index funds already hold shares in companies that could make more money if crude oil, nickel or some other material gets more expensive—and those companies can often turn a profit even if prices stagnate. Companies in the energy, utilities and basic-materials sectors represent about 17% of the market value of the S&P 500, for example.
Then consider the drawbacks. Commodities can provide diversification from stocks and bonds, but they generate no income in the form of dividends or interest payments. They also are vulnerable to prolonged declines, such as the three-year tailspin that culminated in 2013, when a 9.5% drop in the Dow Jones- UBS UBSN.VX +0.50% Commodity Index made commodities the worst-performing major U.S. asset class—including stocks, bonds and real estate—based on total return to investors. By contrast, the S&P gained 32%, including dividends.
"To invest in commodities, you would have to take away from something else in the portfolio. You're taking from equities, with higher returns and the same volatility, or you're taking from bonds that have the same return and less volatility," says Mark Keating, a partner at Willow Creek Wealth Management in Sebastopol, Calif., which oversees $700 million.
Associated Press
The Dow Jones-UBS index has generated a 9.9% return for investors this year through Thursday, compared with a 2.3% return on the S&P 500, according to FactSet.
Even advisers who think commodities can be useful often recommend only small doses, perhaps 3% to 5% of a portfolio. An investor who is particularly concerned about the risk that the U.S. dollar will lose much of its value might hold some gold, which can act as a store of value at times, though it also can behave like a risky asset.
In addition, investors need to carefully study the many mutual funds and exchange-traded funds that have cropped up over the past decade or so to offer exposure to commodities, experts say. The funds often carry steep fees and hidden risks that could eat into returns, so investors should understand how they work.
Here is what investors need to know about what drives commodity prices and how to place a smart wager.
China's Voracious Appetite
From the start of 2000 through the end of 2010, the Dow Jones-UBS Commodity Index, which follows future contracts for 22 commodities from aluminum to zinc, more than doubled. Copper gained 417%, and cotton 184%. The single biggest reason for the rally was that China was growing rapidly.
Still, that only addresses the demand side of the equation. Supplies of many raw materials also were constrained in the years leading up to that decade, because tepid sales and prices had led commodity producers to limit outlays needed to boost output.
That put commodity investors in a strong position, and many rushed to take advantage. Investors had less than $1.8 billion in mutual funds and ETFs that focus on commodities at the end of 2003, but that amount had swelled to more than $182 billion at the peak in August 2011, according to Chicago-based investment-research firm Morningstar.
Now, the situation is different. China's economy is growing more slowly, and ramped-up production of many materials is helping to keep a lid on prices. While many commodity markets are rising, some are falling.
For example, coffee has shot up 94% this year through Thursday, due to a drought in top exporter Brazil, while a virus that has killed millions of pigs has pushed the price of lean-hog futures up 48%. But copper—widely used in appliances, homes and elsewhere—is down 8.2% due to concerns about Chinese growth, while lumber has lost 9.5%.
"When China was growing at 13%, it was almost a no-brainer because China consumes 40% of global commodities," says Shelley Goldberg, an independent commodity strategist who advises institutional clients on investing in sustainable resources. "Today, it's not such a simple story."
Yet there are signs that at least some ordinary investors still hope to ride a hot market.
Between August 2011 and the end of last year—a period when commodity prices were in a funk—investors pulled more than $23.3 billion out of commodity mutual funds and ETFs, according to Morningstar. After pulling out more money in January, investors put $400 million back into the funds in February and March, as commodity markets rebounded.
A Proliferation of Funds
Investors considering following suit have an often-bewildering array of funds to choose from, most of which have relatively short track records by which to judge performance.
The funds fall into two broad categories—those that invest in a wide variety of raw materials across the various commodity subsectors, such as energy, agriculture and precious metals, and those that focus more narrowly on a single sector or even a single material, such as gold, copper or corn.
Broad-based funds are the better choice for an investor who wants general commodity exposure and lacks expertise or conviction about what will happen to prices for a particular type of material.
The broad funds typically track an index of materials, though some follow their index more closely than others.
For example, the iPath Dow Jones-UBS Commodity Index Total Return exchange-traded note closely tracks the Dow Jones-UBS Commodity Index. The fund charges 0.75% in annual fees, or $75 for every $10,000 invested, according to Morningstar.
The largest commodity mutual fund by assets, the $14.1 billion Pimco CommodityRealReturn Strategy Fund, also follows the index to a great degree, but fund managers have some leeway to tweak exposure by, for example, increasing or decreasing holdings of a specific commodity relative to the index or buying futures contracts that won't come due until months later, if they think prices for a certain material are more likely to rise further down the road. The fund charges annual fees of 1.19%.
The funds also have different ways of handling a quirk of the commodities markets. When commodity contracts mature each month, fund managers typically buy the next month's contracts to replace them.
But if prices for the new contracts are higher—a phenomenon known as "contango"—the additional cost can significantly erode the fund's returns. Contango can occur when, for example, there is sufficient supply in the near-term but either a shortage of supply or a surge in demand looms.
Plain-vanilla commodity index funds often don't try to mitigate that risk, which also can work in an investor's favor if the new monthly contracts are less expensive, which is known as "backwardation."
Other funds, such as the PowerShares DB Commodity Index Tracking Fund ETF—the largest broad-based commodity ETF by assets, at $5.7 billion as of Thursday—pick monthly contracts that will come due months down the line in some cases, to limit the damage from contango or maximize the benefit of backwardation. The fund charges 0.85% in annual fees.
Commodity funds can carry other risks that might catch investors off-guard. Purchasing a commodity futures contract typically only requires that an investor or a fund put up a small percentage of the contract's face value, so funds have to decide what to do with the remainder of their assets.
The Pimco fund, for example, has less than a quarter of the fund's capital tied up in commodity contracts, and it tries to give returns a boost by investing most of the remainder in Treasury inflation-protected securities and other Treasurys.
Morningstar noted last August that the fund's declines for the year to that point were largely because bond prices fell as investors began to anticipate a reduction in the Federal Reserve's efforts to stimulate the economy by buying bonds. The fund is up 11% year to date.
Funds that focus on a single type of commodity tend to be smaller. One exception: popular funds backed by gold or other precious metals, which often have lower fees because the cost of actually storing the materials is relatively low.
For investors with strong views on the future prices of particular commodities, there is an array of funds available that track, for example, corn, natural gas or crude oil. But the funds can be risky and sometimes carry high fees.
Hard and Smart
Experts say there are smart ways to hold hard assets, including understanding what purpose they are meant to serve and finding low-cost ways to achieve that aim.
"When we're constructing a portfolio for high-net-worth clients, one of the objectives is to protect real spending and quality of life," says Jeffrey Heisler, investment strategist at TwinFocus Capital Partners, a Boston firm with about $2 billion under management.
"People are natural consumers of food and energy," he says. "Commodities hedge out and diversify and balance that risk we all naturally hold."
The firm's clients collectively held about $3.4 million in a broad basket of commodities through the PowerShares fund as of Thursday, and another $23.3 million in SPDR Gold Trust, an ETF backed by gold bullion. The SPDR fund is the largest retail commodity fund of any kind, with $32.9 billion in assets, and charges 0.40% in annual fees.
Some investors prefer a similar fund also backed by bullion, iShares Gold Trust, which charges 0.25% in annual fees. Individual shares also cost less, because a single share represents 1/100th of an ounce of gold, rather than 1/10th of an ounce for the SPDR fund. The iShares fund has $6.8 billion in assets.
Perhaps most important, investors need to have realistic expectations. Throughout history, commodities markets have gone through periods of boom and bust, and investors who were fortunate enough to hold commodities during the run-up last decade saw what a boom looks like.
But investors also risk a bet going bust. Researchers have found that spot prices for raw materials are flat over time, once inflation is accounted for. In other words, they offer no positive return in the long run.
"An ounce of gold bought a good men's suit or a toga 2,000 years ago, and it buys a good men's suit today as well," says William Bernstein, author of "The Investor's Manifesto" and a co-principal of portfolio manager Efficient Frontier Advisors, based in Eastford, Conn.
Comments
Regards,
Ted
Commodities: To Buy Or Not To Buy ? 4/25/14: Christian Benthelsen WSJ
Part 1
Commodity prices are on the rise, as gold, corn and other basic materials climb back from steep declines—and outpace U.S. stocks.
The rebound may stir hopes that a longer-term boom has resumed after three rough years for natural resources, and a measured bet could pay off.
But for ordinary investors, commodities often are a raw deal. They should take a hard look before loading up.
First, weigh whether you need the exposure. Perhaps the main reason investors hold commodities is to hedge against inflation. But inflation remains muted in the U.S. Moreover, many investors in broad-market index funds already hold shares in companies that could make more money if crude oil, nickel or some other material gets more expensive—and those companies can often turn a profit even if prices stagnate. Companies in the energy, utilities and basic-materials sectors represent about 17% of the market value of the S&P 500, for example.
Then consider the drawbacks. Commodities can provide diversification from stocks and bonds, but they generate no income in the form of dividends or interest payments. They also are vulnerable to prolonged declines, such as the three-year tailspin that culminated in 2013, when a 9.5% drop in the Dow Jones- UBS UBSN.VX +0.50% Commodity Index made commodities the worst-performing major U.S. asset class—including stocks, bonds and real estate—based on total return to investors. By contrast, the S&P gained 32%, including dividends.
"To invest in commodities, you would have to take away from something else in the portfolio. You're taking from equities, with higher returns and the same volatility, or you're taking from bonds that have the same return and less volatility," says Mark Keating, a partner at Willow Creek Wealth Management in Sebastopol, Calif., which oversees $700 million.
Associated Press
The Dow Jones-UBS index has generated a 9.9% return for investors this year through Thursday, compared with a 2.3% return on the S&P 500, according to FactSet.
Even advisers who think commodities can be useful often recommend only small doses, perhaps 3% to 5% of a portfolio. An investor who is particularly concerned about the risk that the U.S. dollar will lose much of its value might hold some gold, which can act as a store of value at times, though it also can behave like a risky asset.
In addition, investors need to carefully study the many mutual funds and exchange-traded funds that have cropped up over the past decade or so to offer exposure to commodities, experts say. The funds often carry steep fees and hidden risks that could eat into returns, so investors should understand how they work.
Here is what investors need to know about what drives commodity prices and how to place a smart wager.
China's Voracious Appetite
From the start of 2000 through the end of 2010, the Dow Jones-UBS Commodity Index, which follows future contracts for 22 commodities from aluminum to zinc, more than doubled. Copper gained 417%, and cotton 184%. The single biggest reason for the rally was that China was growing rapidly.
Still, that only addresses the demand side of the equation. Supplies of many raw materials also were constrained in the years leading up to that decade, because tepid sales and prices had led commodity producers to limit outlays needed to boost output.
That put commodity investors in a strong position, and many rushed to take advantage. Investors had less than $1.8 billion in mutual funds and ETFs that focus on commodities at the end of 2003, but that amount had swelled to more than $182 billion at the peak in August 2011, according to Chicago-based investment-research firm Morningstar.
Now, the situation is different. China's economy is growing more slowly, and ramped-up production of many materials is helping to keep a lid on prices. While many commodity markets are rising, some are falling.
For example, coffee has shot up 94% this year through Thursday, due to a drought in top exporter Brazil, while a virus that has killed millions of pigs has pushed the price of lean-hog futures up 48%. But copper—widely used in appliances, homes and elsewhere—is down 8.2% due to concerns about Chinese growth, while lumber has lost 9.5%.
"When China was growing at 13%, it was almost a no-brainer because China consumes 40% of global commodities," says Shelley Goldberg, an independent commodity strategist who advises institutional clients on investing in sustainable resources. "Today, it's not such a simple story."
Yet there are signs that at least some ordinary investors still hope to ride a hot market.
Between August 2011 and the end of last year—a period when commodity prices were in a funk—investors pulled more than $23.3 billion out of commodity mutual funds and ETFs, according to Morningstar. After pulling out more money in January, investors put $400 million back into the funds in February and March, as commodity markets rebounded.
A Proliferation of Funds
Investors considering following suit have an often-bewildering array of funds to choose from, most of which have relatively short track records by which to judge performance.
The funds fall into two broad categories—those that invest in a wide variety of raw materials across the various commodity subsectors, such as energy, agriculture and precious metals, and those that focus more narrowly on a single sector or even a single material, such as gold, copper or corn.
Broad-based funds are the better choice for an investor who wants general commodity exposure and lacks expertise or conviction about what will happen to prices for a particular type of material.
The broad funds typically track an index of materials, though some follow their index more closely than others.
For example, the iPath Dow Jones-UBS Commodity Index Total Return exchange-traded note closely tracks the Dow Jones-UBS Commodity Index. The fund charges 0.75% in annual fees, or $75 for every $10,000 invested, according to Morningstar.
The largest commodity mutual fund by assets, the $14.1 billion Pimco CommodityRealReturn Strategy Fund, also follows the index to a great degree, but fund managers have some leeway to tweak exposure by, for example, increasing or decreasing holdings of a specific commodity relative to the index or buying futures contracts that won't come due until months later, if they think prices for a certain material are more likely to rise further down the road. The fund charges annual fees of 1.19%.
The funds also have different ways of handling a quirk of the commodities markets. When commodity contracts mature each month, fund managers typically buy the next month's contracts to replace them.
But if prices for the new contracts are higher—a phenomenon known as "contango"—the additional cost can significantly erode the fund's returns. Contango can occur when, for example, there is sufficient supply in the near-term but either a shortage of supply or a surge in demand looms.
Plain-vanilla commodity index funds often don't try to mitigate that risk, which also can work in an investor's favor if the new monthly contracts are less expensive, which is known as "backwardation."
Other funds, such as the PowerShares DB Commodity Index Tracking Fund ETF—the largest broad-based commodity ETF by assets, at $5.7 billion as of Thursday—pick monthly contracts that will come due months down the line in some cases, to limit the damage from contango or maximize the benefit of backwardation. The fund charges 0.85% in annual fees.
Commodity funds can carry other risks that might catch investors off-guard. Purchasing a commodity futures contract typically only requires that an investor or a fund put up a small percentage of the contract's face value, so funds have to decide what to do with the remainder of their assets.
The Pimco fund, for example, has less than a quarter of the fund's capital tied up in commodity contracts, and it tries to give returns a boost by investing most of the remainder in Treasury inflation-protected securities and other Treasurys.
Morningstar noted last August that the fund's declines for the year to that point were largely because bond prices fell as investors began to anticipate a reduction in the Federal Reserve's efforts to stimulate the economy by buying bonds. The fund is up 11% year to date.
Funds that focus on a single type of commodity tend to be smaller. One exception: popular funds backed by gold or other precious metals, which often have lower fees because the cost of actually storing the materials is relatively low.
For investors with strong views on the future prices of particular commodities, there is an array of funds available that track, for example, corn, natural gas or crude oil. But the funds can be risky and sometimes carry high fees.
Hard and Smart
Experts say there are smart ways to hold hard assets, including understanding what purpose they are meant to serve and finding low-cost ways to achieve that aim.
"When we're constructing a portfolio for high-net-worth clients, one of the objectives is to protect real spending and quality of life," says Jeffrey Heisler, investment strategist at TwinFocus Capital Partners, a Boston firm with about $2 billion under management.
"People are natural consumers of food and energy," he says. "Commodities hedge out and diversify and balance that risk we all naturally hold."
The firm's clients collectively held about $3.4 million in a broad basket of commodities through the PowerShares fund as of Thursday, and another $23.3 million in SPDR Gold Trust, an ETF backed by gold bullion. The SPDR fund is the largest retail commodity fund of any kind, with $32.9 billion in assets, and charges 0.40% in annual fees.
Some investors prefer a similar fund also backed by bullion, iShares Gold Trust, which charges 0.25% in annual fees. Individual shares also cost less, because a single share represents 1/100th of an ounce of gold, rather than 1/10th of an ounce for the SPDR fund. The iShares fund has $6.8 billion in assets.
Perhaps most important, investors need to have realistic expectations. Throughout history, commodities markets have gone through periods of boom and bust, and investors who were fortunate enough to hold commodities during the run-up last decade saw what a boom looks like.
But investors also risk a bet going bust. Researchers have found that spot prices for raw materials are flat over time, once inflation is accounted for. In other words, they offer no positive return in the long run.
"An ounce of gold bought a good men's suit or a toga 2,000 years ago, and it buys a good men's suit today as well," says William Bernstein, author of "The Investor's Manifesto" and a co-principal of portfolio manager Efficient Frontier Advisors, based in Eastford, Conn.
"The relative value hasn't changed
.
WSJ In-Depth