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With
markets roiling from uncertainty, investors looking to
dodge some of the volatility might benefit from putting
their money into one of the most volatile asset classes
around — commodities.
Sounds
counterintuitive, right? Chaotic trading on the
Chicago Mercantile Exchange
floor, futures contracts, speculators. The terms don't
exactly bring to mind the predictability so many
investors seek. But for long-term investors desiring
insulation from price swings in traditional assets, such
as stocks and bonds, moving some money into a broad
basket of commodities — wheat, oil, cattle, precious
and industrial metals — could be a good bet.
Experts
tout commodities as a good hedge against inflation
because the price of raw materials tends to rise with
the price of the goods they're used to make.
They also
point to their historically negative correlation with
the price movement of traditional assets. As described
by
Mike Brown
, first vice president of investments for
UBS Financial Services
in
St. Louis
, it's an investment "that zigs when others zag."
Other
analysts agree that, used correctly, commodities can
help protect a long-term investor's portfolio from
shifts in the prices of their other assets.
Putting
some money into a number of different commodities can
reduce your portfolio's overall volatility and still get
returns similar to a portfolio with just stocks and
bonds, said
Paul Christopher
, senior international investment strategist with
Wells Fargo Advisors
.
Since the
market crash of 2008, investors have been looking for
alternatives to traditional stocks and bonds.
Commodities have been one of those asset classes, and
financial analysts and advisers say their popularity has
grown noticeably.
Standard
& Poor's GSCI, a broad commodity index, had about
$60 billion
in financial instruments pegged to it in
February 2007
, when Goldman Sachs sold the index to Standard and
Poor's. As of the end of March, there was an estimated
$75 billion to $80 billion
tracking it.
The Dow
Jones-UBS Commodity Index, another broad-based index,
had about
$24.9 billion
tracking it in the second quarter of 2006. By the end of
2009, it had
$54 billion
following it.
Some of
that is based on access. Once virtually inaccessible for
ordinary investors, new financial instruments produced
over the past several years have made it possible to get
exposure to commodities without worrying about ending up
with a warehouse full of soybeans.
"There's
really been an explosion of vehicles for ordinary
investors to get commodity exposure," Christopher
said.
Mutual
funds that invest in commodity futures and equities in
businesses such as mining companies have grown more
common. Instruments such as exchange-traded funds, or
ETFs, which trade like stocks, invest in a number of
securities and allow investors to get commodity exposure
with the ease of equity trading. For investors new to
commodities, analysts recommend they put no more than 10
percent of their portfolio into commodity-related
products.
But
getting the broad benefits of commodities isn't as easy
as just buying gold bullion or stock in
Alcoa
. To get the inflation hedging and negative-asset
correlation advantages, investors should invest in
instruments that are broadly exposed to agriculture,
livestock, metals and energy commodities. Even then,
expect a relatively volatile asset in the short run.
"Our
advice for the average investor is not to pick a
specific commodity, but invest in a basket," said
Cindy Rapponotti
,
Commerce Trust Company's
director of alternative investment strategy.
Rapponotti
recommends that investors who have yet to venture
outside of stocks and bonds use products that track a
diversified commodity index. She likes the Dow Jones-UBS
Commodity Index. Unlike the S&P GSCI, which is
weighted based on changes in global production for a
particular resource and tends to be heavy in energy, the
DJ-UBSCI never allows a group of commodities to make up
more than 33 percent of the index and has less energy
exposure and more diversification.
Investing
in businesses that are dependent on commodities, such as
mining and energy companies, can provide similar
benefits to the actual thing, but equities still retain
exposure to broader market forces. Instruments that
track broad indexes or invest in the materials
themselves offer purer exposure.
Long-term,
Christopher is bullish on commodities. As developing
economies continue their growth and urbanization, he
expects global demand for raw materials to continue
increasing. Add that to the fact that many commodities
are becoming harder to access and extract, upward
pressure on commodity prices could stay strong for a
generation, he said.
But,
short-term, Christopher cautioned, there's still an
inventory cycle associated with prices. That can run its
course in a matter of months, whereas companies'
business cycles sometimes take years, he said.
Just look
at the commodity price plunge in May. Most investors
aren't used to 10 percent to 15 percent fluctuations in
their portfolios, Christopher said.
"So,
the question is, long-term, how much investors will get
seasick from that up and down?" he said.
As for
the inflation-hedging aspect of the investment, Brown
doesn't see much risk for rising prices in the short
term. The Federal Reserve is keeping interest rates low,
and there's still substantial slack in the economy. But
now is as good a time as ever to protect oneself from
inflation, he said.
"If
you're a long-term investor, you don't know when it's
going to happen. But certainly the fundamentals are in
place for it," Brown said.
For
investors seeking to hedge against fluctuations in
stocks and bonds, however, nothing is a sure bet.
Guofu Zhou
, a professor of finance in
Washington University's
Olin Business School
, notes that in a crisis, asset prices can quickly begin
moving together. During the 2008 market crash, commodity
prices dropped off a cliff just like everything else.
That
makes
David Rolfe
, chief investment officer at
Wedgewood Partners
, skeptical of the conventional wisdom that diversifying
into alternative asset classes can insulate investors
from market shifts.
"When
the world collectively says 'sell,' the only thing that
will help you is cash," he said.
Diversification
is always a good strategy, but with world markets
becoming more correlated, diversification is not as
effective as it once was, Rolfe said.
The
growing popularity of commodity investments means
"there's an enormous amount of money chasing a
relatively small subset of the economy," he said.
That
could be artificially inflating prices and pushing down
future returns.
In
today's market, a good hedge is hard to find, and not
likely to get any easier.
"What
did Yogi Berra say? 'The world is becoming more of a
global place every day,' " Brown of UBS said.
"We are becoming one big market."
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