Is Now the Time to Add Commodities?
by Jeffrey M. Mercer , Mitchell Conover , Robert R. Johnson and Gerald R. Jensen
Excerpted from the Fall 2010 issue of The Journal of Investing.
With the recent increase in equity volatility, commodity investments have garnered significant attention from investors. Previous research has found substantial benefits associated with commodity investments, but there remains considerable uncertainty regarding the consistency and general applicability of those benefits for equity investors.
In this article
- Interest in Commodities Up
- How the Study Was Conducted
- Results
- Tactical Allocations
- Tactical Allocation Versus Strategic Allocation
- Conclusions
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We provide evidence that helps to resolve some of the uncertainty with regard to commodity investments. Specifically, based on a sample period of 36 years, we show substantial benefits to commodity investments regardless of the equity style an investor pursues. To obtain a significant benefit, however, requires a commodity allocation of greater than 5%. Interestingly, adding a commodity exposure enhances an equity portfolio’s return only during periods when the Federal Reserve is increasing interest rates, which is consistent with the belief that a major attraction of commodities is that they serve as an inflation hedge. Furthermore, an allocation to commodities in a tactical asset allocation using monetary conditions consistently outperforms both a strategic commodities allocation and an all-equity portfolio.
Interest in Commodities Up
Commodity futures have increasingly garnered interest as a viable component of individual investors’ portfolios. Much of the interest is attributable to research espousing the benefits of adding commodity exposure to equity portfolios. For example, three of this study’s authors—Gerald Jensen, Robert Johnson and Jeffrey Mercer (2000, 2002)—as well as Gary Gorton and Geert Rouwenhorst (2006) show that commodity futures returns are comparable to equity returns over long periods of time, and confirm that the contracts offer considerable diversification benefits due to their low (or even negative) correlation with equities. The low correlation appears to be driven by the unique performance of the contracts during inflationary periods. Since increasing commodity prices are typically one element of heightened inflation and higher interest rates, both of which tend to negatively affect equities, long positions in commodity futures are found to provide an inflation hedge for equity portfolios.
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Mitchell Conover , Ph.D., CFA, is an associate professor of finance at the Robins School of Business, University of Richmond.
Robert R. Johnson , Ph.D., CFA, is the senior managing director at the CFA Institute.
Gerald R. Jensen , Ph.D., CFA, is a professor of finance at Northern Illinois University.
Discussion
The article intuitively makes sense and seems timely given the current low interest rate environment. Currently conservative investors are suffering the low interest rate environment. When rates rise, then what? Are commodities an alternative to high stock market allocations?
posted over 2 years ago by Andrew from New York
One question that crossed my mind is, couldn't returns be improved during a restrictive period by buying an ETF that shorts the commodity index?
posted over 2 years ago by Norman from South Carolina
This article on the benefits of adding commodities to a stock portfolio is a very well-constructed piece of research. However, it fails in one key way - there is no way to take the results of a study looking at just two asset classes and apply them to a real world portfolio comprised of many asset classes.
For example, the authors conclude that a 10% allocation to commodities in an otherwise all stock portfolio is the minimum allocation that will provide statistically significant diversification benefits. However, the article says nothing about how to apply this result to a portfolio with a smaller allocation to stocks.
Further, the authors could study how the minimum allocation differs between an investor with two or three basic asset classes in their portfolio and a similar investor with a portfolio diversified across six or seven asset classes.
posted over 2 years ago by Darren Cooper from Indiana
Also GCC is an interesting ETF to consider
posted about 1 year ago by Christopher from Massachusetts
Dear Editor:
I do own a small amount of physical gold and silver,mostly in coins. The total value in today's market is about US$60K. All of them were purchased before 1985. I've kept them not for investment purposes but for unforeseen financial catastrophes,real great disasters like national default on debts or total government collapse in Washington. (Please do not laugh at me - With all the bozos doing unthinkable things there,anything could happen!) At least I'd have enough to buy bread,milk and butter for a year and then think what to do next-----.
Respectfully yours,
Henry Liu(LIfe member,AAII)
posted about 1 year ago by Henry from Michigan
