The Case Against Commodities

That is the title of the article from The Wall Street Journal.  Not a damning case, but one that touches on all of the major weaknesses and risk factors of investing in commodities in all of their manifestations.  There is the substitution effect, such as when kerosene replaced whale oil in lamps.  There is the technology effect of applying hydraulic fracturing (and horizontal drilling) to shale formations to vastly increase the productivity of natural gas wells.  There is also more speculative capital in the market, attracted through very retail friendly vehicles such as ETFs and structured notes.

Finally, there is contango to overcome in the futures market where most of that ETF capital is deployed.   Contango is the normal stateof pricing in which a longer dated contract is more expensive than a shorter contract.  Thus, with the expiration of each contract, an investor has to pay more to re-establish the position than the proceeds from closing the contract.

Two striking passages hit home.  Dylan Grice of Societe Generale is credited with the observation that "(s)pot prices for raw materials have been basically flat, after adjusting for inflation, since 1871, vastly underperforming stocks and bonds...."  And this from author William Bernstein: "You're picking up nickels in front of a steamroller.  The risk of getting crushed is enormous."

The typical diversified portfolio has some exposure to commodities through the stocks of commodity producers.  Think ExxonMobil and Archer Daniels Midland. The type of commodities investing discussed in the WSJ article is speculative exposure to price changes.  A more conservative approach to increasing exposure would be to invest in a sector fund focusing on commodities producers such as Fidelity Global Commodity Stock Fund (FFGCX).