If soaring commodity prices haven’t caught your attention, maybe the rising number of exchange-traded products tracking them has. Halfway through the second quarter of 2007, there were 17 such products tracking both broad sector and single-commodity indexes.
One such example is the iPath Dow Jones AIG Commodity Index ETN (NYSE: DJP), an exchange-traded note (ETN) launched in mid-2006. As a commodity basket, this index note tracks the price of 19 different commodities. Included in this group are all of the usual suspects, including crude oil, unleaded gas, copper, gold and silver. A few of the lesser-known constituents are cattle, soybeans and wheat.
At the end of 2006, the Dow AIG Commodity Index notched five-year annualized returns of 16.10 percent, handily outperforming bonds and key stock indexes like the Dow Jones Industrials, Nasdaq-100 and S&P 500. Who says stocks and bonds give you all the diversification you’ll ever need? For sure, diversification isn’t what it used to be. Slowly, financial professionals are coming to the realization that true diversification can’t be achieved through stocks, bonds and real estate alone.
Perhaps the biggest selling point of commodities is their negative historical correlation to stocks and bonds. On any given day, if commodities are zagging, everything else is zigging — and vice versa. For portfolios with exposure to “everything else,” this renders the valuable service of reducing volatility by increasing diversification. Toss in the fact that commodities have long been considered an excellent hedge against inflation, and their usefulness becomes even further cemented.