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I'm wondering about investment in commodities (through derivatives such as futures for example). What would they offer new in a multi-asset portfolio? Probably some diversification, but what else? (including negative effects)

Answers about commodities in general interest me, but also for singles commodities (like the interest in investing in gold, in oil, in wheat,...)

Thank you for your help

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    Pro: If you have a buddy in the business you will help make him some money. Con: You will lose all or most of your money. – Pete B. Apr 20 '15 at 17:08
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The main advantage of commodities to a largely stock and bond portfolio is diversification and the main disadvantages are investment complexity and low long-term returns.

Let's start with the advantage. Major commodities indices and the single commodities tend to be uncorrelated to stocks and bonds and will in general be diversifying especially over short periods. This relationship can be complex though as

  • Oil and non-precious metals often see the demand fall in a crisis
  • Agriculture (especially non-meat) tends to have fairly consistent demand as people need to eat
  • Precious metals often have high demand in a particularly bad crisis

Supply can be even more complicated (think weather) so diversification may or may not work in your favor over long periods.

However, trading in commodities can be very complex and expensive. Futures need to be rolled forward to keep an investment going. You really, really don't want to accidentally take delivery of 40000 pounds of cattle. Also, you need to properly take into account roll premiums (carry) when choosing the closing date for a future. This can be made easier by using commodities index ETFs but they can also have issues with rolling and generally have higher fees than stock index ETFs.

Most importantly, it is worth understanding that the long-term return from commodities should be by definition (roughly) the inflation rate. With stocks and bonds you expect to make more than inflation over the long term. This is why many large institutions talk about commodities in their portfolio they often actually mean either short term tactical/algorithmic trading or long term investments in stocks closely tied to commodities production or processing.

The two disadvantages above are why commodities are not recommended for most individual investors.

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    I would be careful by highlighting the diversification benefit. Recent research indicates that the diversification benefit might be disappearing. Furthermore, I would not say that commodities yield low returns. This is highly dependent on the weighting and roll scheme used. Commodities could yield "equity-like returns" (E.g. Erb & Harvey (2006) & Gorton & Rouwenhorst (2006) ). In addition, in line with what you mention, commodities tend to be a good inflation hedge. – user24453 Apr 23 '15 at 14:37
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    "Does the average commodity futures have ‘equity-like’ returns? Our research suggests that this has not been the case: the average returns of individual commodity futures contracts have been indistinguishable from zero." Erb and Harvey (2006) – rhaskett Apr 23 '15 at 17:43
  • If you would have read my comment carefully you would have noticed that I did not speak of a single commodity but about commodities. Obviously trading a commodity is a zero-sum game. Investing in multiple commodities however could yield returns (depending on the weighting and roll scheme). However, you know this as the sentences following the sentence that you copied mentions this phenomenon: "Might portfolios of commodity futures have equity-like returns? Here, the answer seems to be maybe." (Erb and Harvey, 2006). Supporting your answer by cherry-picking does not help the community. – user24453 Apr 24 '15 at 13:42
  • When most retail investors invest in commodities they generally go long a single or occasionally multiple commodities over a period of time. So the quote above (from the conclusion!) seems more relevant than the subsequent "maybe" which can rely on things like "skewing portfolio exposures towards commodity futures that are highly certain to have positive roll or spot returns in the future" which seems unlikely for an individual investor. Not to mention that their calculations don't take into account the higher trading/roll/margin costs most would experience. – rhaskett Apr 24 '15 at 18:11
  • @thenoob I would encourage you to add to the answers below where you can devote more space supporting your points. The disappearing diversification benefit is a particularly timely and relevant. – rhaskett Apr 24 '15 at 18:37
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Another disadvantage is the inability to value commodities in an accounting sense. In contrast with stocks, bonds and real estate, commodities don't generate cash flows and so any valuation methodology is by definition speculative. But as rhaskett notes, there are diversification advantages. The returns for gold, for instance, tend to exhibit low/negative correlation with the performance of stocks. The question is whether the diversification advantage, which is the primary reason to hold commodities in a multi-asset class portfolio through time, overcomes the disadvantages? The answer... maybe.

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