By John Wasik
CHICAGO Jan 28 Commodities are among the most
skittish investments. Not only do they react to global economic
forces, they can seesaw with supply and demand, China's
voracious appetite for raw materials and the weather.
Since commodities are tangible things that are mined or
grown, they are hard to hold and often bought through futures
contracts, which have their own peculiarities. Yet what is
undeniable about commodities is that they are usually a good
tracker of broad economic growth, inflation among producer
prices and they run inversely to the dollar's decline. You
should have a piece of them in your portfolio, but you have to
be careful about how you hold them.
Here's how strange commodities are: Even though there was
growth nearly everywhere except for Europe last year,
commodities, as measured by the Dow Jones/UBS commodities index,
declined 1 percent. That compares to a resounding 16 percent
gain for the S&P 500 index of large U.S. stocks with dividends
Commodities prices have been following muted expectations
for the Chinese economy in recent years, which is now the
world's largest consumer of raw materials.
Despite predictions last year that the Chinese export-driven
economy would cool down due to slack demand in the euro zone and
the U.S., according to HSBC, China's 8-percent growth rate may
not slow down this year. The IMF reports that China is consuming
some 40 percent of base metals, 23 percent of agricultural
products and 20 percent of non-renewable energy resources.
Renewed growth in China -- 8.2 percent according to the 2013
IMF estimate last week -- will translate into heavier demand for
ores, oil, coal and agricultural goods. The rebound may have
already begun. Factory sector growth in China hit a two-year
high this month, says HSBC.
Eric Weigel, director of research for the Leuthold Group in
Minneapolis, says you have to be careful with how you play the
"China effect." Buying baskets of commodities through managed
index funds can skew results because of the funds' weightings.
The Dow Jones/UBS index, for example, has twice as much invested
in agricultural commodities than the rival S&P/Goldman Sachs
Commodities Index, which has more than 60 percent of its
holdings in energy.
It's hard to execute a commodities strategy using baskets,
says Weigel. "From 2003 through 2007, that strategy did well,
then fell apart." This was the nasty little secret of
commodities, which were supposed to move in the opposite
direction of stocks, providing some diversification.
Indeed, when worldwide demand for raw materials plummeted
after the 2008 meltdown, commodities followed stocks, which
dropped 37 percent. The S&P/GSCI got punched even more --
falling 46 percent that year. This high correlation blindsided
many investors like myself, who were looking at historical
numbers that suggested commodities moved in the opposite
direction of stocks.
What's the best way to avoid falling into lockstep with
stocks while using commodities as an inflation or a dollar
hedge? Investing in a popular fund such as the PowerShares DB
Commodity Index Tracking ETF has not worked recently.
Although it holds more than half of its portfolio in petroleum
products, it has returned 4 percent over the past three years
through 2012. The fund was hurt by its large exposure to energy,
as wholesale prices in that sector fell.
An alternative such as the iShares GSCI Commodity-Indexed
Trust is similar, investing nearly 70 percent of its
portfolio in energy futures, about 20 percent in agriculture and
livestock and 10 percent in industrial and precious metals. It
has gained 1.22 percent in the last year.
To boost your returns, a more focused approach might be a
better way to play specific trends, such as the increased use of
metals and petroleum products in Asia.
The Energy Select Sector SPDR focuses on major
petroleum producers, pipelines and service companies, so you
avoid the exposure to the other commodities. It returned almost
10 percent over the last three years and could more closely
track growing demand for oil and its byproducts in emerging
Another approach is to invest in a broader basket of stocks
that concentrates on metals, chemicals and minerals needed in
emerging economies. With that road map, a fund like the Vanguard
Materials ETF could be a suitable choice. The fund holds
big mining companies like Freeport McMoRan Copper and Gold
, major chemical producers like Dow and
agricultural companies like Monsanto. The fund gained
almost 10 percent over the last three years and more than 17
percent last year.
However you craft your commodities strategy, take the long
view. Commodities are among the most volatile asset classes. It
is probably less risky to buy and hold companies that benefit
from global growth and pay dividends than investing in funds
that have futures-based strategies.
Also keep in mind that this asset class only performs well
if there is growing global demand for commodities. Recessions or
slowdowns will bruise returns. Advanced economies are only
expected to grow 1.4 percent this year, the IMF predicts. Raw
materials prices are also incredibly volatile, so keep this
section of your portfolio under 10 percent of total holdings.
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Editing by Lauren Young and Phil Berlowitz)