To begin this article, here is a little quiz (in good Jeopardy! fashion, the answer comes first):
Answer: 112%, 107%, 86%, and 79%.
Question: What are the spot returns for cotton, silver, coffee, and corn from December 2009 to May 2011?
The fact is that commodities have been on a tear for some time (the source of those return numbers, btw, is S&P GSCI spot returns.) Crude oil, for example, is up 47% over that same 18 month period while gold, everybody’s favorite commodity, has jumped 30%. Even a diversified basket of goods like the one represented by the Dow Jones-UBS Commodity Index is up 22% for the stretch.
These are outsized numbers, to be sure, but that doesn’t mean advisors shouldn’t still be considering commodities for their clients’ long-term investment portfolios. We think they should, and here are a few reasons why:
Reason No. 1: Commodities Are an Inflation Hedge Over the years, we’ve all come to appreciate commodities for their inflation hedging properties. And rightfully, so according to the statistical relationship between the DJ UBS Commodity Index versus and the Consumer Price Index (CPI) as shown in Chart 1 below.
The graph, which goes to back to the Index’s inception in January 1991, clearly shows that having exposure to a broad basket of commodities has consistently provided investors a good degree of purchasing power protection. The relatively high R-squared value (.82) indicates that the returns to commodities are, in fact, partially explained by inflation over long-term time periods. There’s no reason to believe that will change.
Reason No. 2: Commodities Are a Diversifier Just as important, commodities provide an important diversification benefit over time when paired with a portfolio of stocks and bonds. Chart 2 below shows the R-squared numbers of a blended portfolio of 60% S&P 500 Index / 40% Barclays Aggregate Index versus the DJ UBS Commodity Index over several time frames from the Index’s inception.
Clearly, exposure to commodities over the long term would have diversified a simplified portfolio of stocks and bonds.