Sunday, March 28, 2010

Should Small-Time Investors Dabble in Commodities?

Gold Investing

Jim Rogers on Commodities

For the average small-time investor, it's best to turn off CNBC and Fox Business News, and concentrate on increasing earning power and savings.  However, these days with so much fear and uncertainty in the economy and over the levels of government spending it's no wonder people are looking alternative investments to traditional stocks and bonds.

Commodities seems to be word on the lips of many investment gurus.  What's the case for investing in commodities?  I've attached two videos that attempt to make the case for commodity investing... a world where basic materials, food and energy are getting scarcer as populations grow, governments that are irresponsible with their currencies, run excessive deficits and borrow well beyond their means to repay, economic uncertainty and political fear.  But could this be a case of short-term performance chasing, or is there long-term value in this sector?

But how do you value a single commodity or an index of commodities?  I wish I knew.  There are no profits, cash flows or dividends, only asset appreciation or depreciation as supply and demand are balanced in the marketplace.  How do you know if gold is a bargain at $1100 an ounce?  Don't know the answer to that question either.

I do know that the price of commodities will never go to zero, because these are the raw materials used to make things humans need such food, clothing, shelter, heat, transportation, machines, etc.  I also know that as the world gets more affluent demand rises for the finished goods made from these raw materials.  But do they make a good long-term investment as some pundits indicate?  I am skeptical.  Long-term charts seem to indicate they barely keep pace with inflation, and stocks and bonds outperform.  But, as with any investment, past performance does not indicate future results.  To invest in commodities you must be a believer in resource scarcity or the currency debasement story.

What are the individual's choices in commodity investing?  Mutual funds, ETFs, ETNs and taking possession of the commodities themselves.  I'd stay away from ETNs due to counterparty risk, and, except in the case of gold and silver coins or bullion, shy away talking physical possession of commodities.  I'd concentrate my efforts on identifying mutual funds and ETFs such as:
  • Pimco Commodity Real Return Fund
  • PowerShares DB Commodity Index Tracking Fund (DBC)
  • iShares GSCI Commodity-Indexed Trust Fund (GSG)
  • iShares Gold Trust(IUA) or SPDR Gold Shares (GLD)
  • iShares Silver Trust (SLV)
But be warned, the broad based commodity ETFs and funds have a spotty record at replicating the performance of the indexes.

For the well-diversified investor, I view commodities as a hedge or insurance against economic fear and uncertainty.  They tend to move counter-cyclical to other financial assets and this add to their appeal to reduce the volatility of portfolios.  In my view, stocks and bonds will outperform commodities long-term, and that is where I am placing my money. But for those who must invest in commodities, I think it would be a mistake to have more than 5-10% of a portfolio in this sector.


  1. I would have no problem putting up to 10% in basic commodity funds because I look at it as a play on expanding global markets and an inflation hedge. I am not a fan of gold however and it wouldn't surprise me if those piling on the band wagon get pounded. Although, as you point out, gold has some industrial uses it is basically a speculation rather than an investment. For the record I am a fan of Jim Rogers.

  2. Hi Robert,

    I'm a Jim Rogers fan too, and a believer in the global commodity demand story. Not 100% satisfied with the investment choices in the commodities area though. Some of the giants of index investing like Bogle and Malkiel seem to lump commodity investing into the speculation category.