Commodities add diversification not risk

Investing legend Jim Rogers created his own commodity index (The Rogers International Commodity Index) in anticipation of a new cyclical commodity bull market. It came, though it did not last as long as he anticipated (the 2008 credit crisis and resultant deflationary pressure ended nearly all bull markets). So much money flowed into various commodity indexes that some analysts and many politicians, blamed the rise in prices—particularly crude oil—on the indexes themselves and not the underlying fundamentals of the market.

The claims were highly dubious because the products were not leveraged; investors received a dollar per dollar access to a basket of commodities. The question of whether the indexers and/or the market participants making markets for them should legitimately be considered bona fide hedgers and receive exemptions from position limits and accountability levels was another concern. The Dodd-Frank Act included provisions that the Commodity Futures Trading Commission establish new position limit rules.

Deep contango markets also served as a headwind to these investments, as the structure of the investments involved rolling spot month holdings into longer dated (more expensive in contango markets) contracts on a continual basis.

None of this is to argue for a passive long investment in commodities — there is plenty of research out there for people who want to investigate whether such an investment is appropriate — it is simply to point out that the WSJ story set up a false choice and cherry picked data. Most advocates of commodity investing — active and passive, long only and long/short— recommend it as a way to diversify a portfolio, to augment a classic mix of stock and bonds. Quite a bit of strong research has shown these investments have tended to both improve overall returns while reducing overall volatility.

Several years ago Bloomberg published a series of articles criticizing alternative investments. It attacked hedge funds in one and managed futures in another. Similar to this piece (but worse) it cherry picked data, highlighting periods of growth in equites and not including market reversals like in 2008. It compared equities vs. alternatives in positive equity market environments and didn’t acknowledge that these alternatives are meant to provide diversification, which has proved over time to reduce overall portfolio volatility. Instead of a 60/40 portfolio a 50/40/10 or 45/35/20 allocation is suggested with 10% or 20% going to alternatives that have shown to perform well in bear equity markets and have proven to reduce overall volatility.

Like the Bloomberg pieces, this doesn’t seem to offer another option to diversify. Absent that, it is suggesting a more concentrated allocation to equities. Coming as it does at the beginning of the ninth year of an historic bull equity market strikes us a bit irresponsible.


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