Earlier this year, strategists and investors came out in droves to embrace commodities to weather surging inflation. This looked like a brilliant move at first as oil, metals and grains all rallied, but investors who held on to those positions are seeing their winnings largely eviscerated by a brutal snapback. In reality, most individual investors had no business investing in commodities in the first place.
Commodities can make for great trades, but they are often lousy investments. Unless you happen to own your own warehouse, you assume a cost to store them, which means it’s hard to make any money holding them for the long term. If investors get in at a peak chasing fad portfolio construction techniques, the returns can be much worse.
The Bloomberg Commodities Index is a good illustration. On a spot basis, it is up 351% in the past two decades, a respectable 7.8% compound annual growth rate that’s just slightly behind the S&P 500 Index’s 9.3%. But that’s not what investors earn when they invest through financial instruments because it doesn’t account for the cost of rolling such futures contracts. Among other things, there’s a sizable cost associated with storing barrels of crude oil, tanks of natural gas and bushels of wheat. In part because of these additional costs, the total return version of the same index — based on financial instruments that track the commodities — is up only 50% in the same period (a meager 2% compound annual growth rate).
Perhaps as important, it’s now down 14% from April, when trendy allocations to commodities took off to chase the surge in energy and wheat prices after Russia’s invasion of Ukraine. A Bank of America Corp. fund manager survey for April showed investors were the most net overweight ever for commodities that month. Even after outflows in the past month, the Invesco Optimum Yield Diversified Commodity Strategy ETF remains a top 50 exchange-traded fund in the US by 2022 inflows.
Modern investors tend to fall back on the idea that diversification goes hand in hand with responsible investing, and there’s a tendency to assume that it is good to own as many asset classes as possible. That really depends on an investor’s time horizon, though, and it may be a fool’s errand for working-age people with decades to invest if the portfolio diversifiers curb returns. To borrow a phrase from Universa Investments founder Mark Spitznagel, the diversification cure embedded in many modern risk-mitigation techniques is worse than the disease. I’d argue that logic extends to commodities.
Consider how the various asset classes have performed over long periods: The S&P 500 is up 493% in the past 20 years, while Treasuries earned 87% compared with the 50% for commodities. If you had the time and the stomach for the volatility, it paid to simply own stocks. In other words, good-intentioned risk management may indeed smooth out single-year returns, but the same strategies can be such a drag on the long-term performance that they may not be worth it.
It’s not surprising that the market found itself grasping at straws earlier this year and ended up landing on commodities. The economy, of course, is going through a period unlike any other since the inflationary 1970s, and the tricks that seemed to work in the recent past clearly lost their magic.
Oil, wheat and bars of gold made as much sense as anything else if the economy were truly barreling toward an era of stagflation, but that doesn’t seem to be the base case at this stage. Federal Reserve Chair Jerome Powell has said he’s committed to raising interest rates until inflation cracks, and global growth is diminishing rapidly, meaning the industrial metals juggernauts of earlier this year are collapsing just as fast as they went up. The slowdown in China, which drove the last commodity supercycle, is part of the reason.
Clearly, the economy is in a strange place with a multitude of confusing crosscurrents. A strong job market continues to belie other signs of strain and — who knows? — maybe oil, copper and other commodities could take another run at their highs. Those commodities allocations investors built up earlier this year could yet pay big. But even if they do, they will go down as a well-timed trade, not a reliable strategy. Odds are commodities will never be a sound long-term investment.
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