Blogs & Comment

Commodities as an asset class

Anew book by John Stephensonis focusing attention within the blogosphere (e.g. Canadian Capitalistand Michael James)on commodities as an asset class with long-run returns equivalent to stocks, lower volatility and no correlation to stocks. It might be supposed adding commodities to portfolios makes sense for at least U.S. investors because of the low representation of commodity producers on U.S. exchanges. But even for this group, the view of commodities as a way to lower portfolio risk and/or enhance returns may be one past its Best Before date.
Up to the 2000s, it might have paid off to diversify into commodities. But then a 2004 research paperby two Ivy League university professors on the long-run returns, volatility and correlations of commodity futures flicked on the spotlight. So did a 2006 Ibbotson Associates studypointing out how portfolio returns could be enhanced for a given level of risk by adding commodity futures.
For investment managers following modern portfolio theory, these findings were golden. They now had a chance to diversify into supposedly uncorrelated assets. Institutional investors accordingly shifted substantial funds into the commodity nexus. The development of commodity index funds and exchange-traded funds facilitated the inflow of money into commodities for both institutional and retail investors.
Indeed, the influx of new money and escalating commodity prices attracted the attention of the U.S. Senate, and hearings were held in 2008. Some Senators even called for limits on index investing in the markets (not acted upon).
The presence of new kinds of investors (with motivations and objectives different from the hedgers and speculators) has altered commodity markets. The latter are now subject to forces different from those in the periods covered by the research studies (the actions of passive index investors are new factors impacting the prices of commodity futures). I wouldn’t necessarily expect commodities to continue performing as they may have performed in the decades before the2000s i.e. registering average returns similar to stocks at lower levels of risk and with low correlations to stocks.