In recent months, market volatility has been at the forefront of investors’ minds.
John Love, president and CEO at United States Commodities Funds, believes commodity ETFs can help investors manage some of the volatility currently in the broader stock market.
United States Commodities Funds currently has 12 commodity ETFs listed in the U.S.
During a phone call with media and several firms that participate in Schwab’s OneSource ETF platform, Love discussed why he thinks there’s a place for commodity ETFs in portfolios today.
“Commodities over the long term have a negative correlation to stocks and bonds,” he said.
While U.S. equities are closely related to each other and have a positive correlation with one another, commodities act as a bet on unexpected inflation and have a low to negative correlation to other asset classes. That negative correlation also helps explain commodities’ underperformance last year, when stocks were performing better than they are now.
“2015 was especially a tough year for commodities,” Love said. “Of the 27 commodities that USCF tracks, only three had positive returns. That was sugar, cotton, and cocoa, and everything else was down and some things were especially down.”
Interestingly, according to Love, the worst performing commodity wasn’t crude oil, which was down 30%. Believe it or not, it was nickel — down about 42%.
“We had sort of a strong stock market,” Love said. “Commodities have a floating negative correlation to stocks and bonds. So it makes sense that commodities underperformed and everyone just piling into the stock market.”
Another thing that can make commodity ETFs attractive during times of market volatility is the fact that “commodities are generally uncorrelated to each other.”
Correlation is significantly lower in a commodity basket than among the S&P 500, Love said. There’s very little correlation between oil and gold and livestock, he added.
Love also gave some tips on what investors need to look for in evaluating commodity ETFs.
“They need to look at what they’re exposed to,” he said.
Rather than a product that sits in one commodity, Love suggests a broad basket that has a collection of commodities.
“With commodities, what the index holds – is it weighted in energy? Is it fully weighted? Does it have a way to reduce overweight [commodities]?” Love explained. “You have to consider how does the portfolio … How does it choose weight? How is the basket correlated to other assets? All of that should be evaluated.”
Investors will want something that reallocates to the stronger commodities, Love said.
When looking at commodity indices overall, the spread between performances is “pretty dramatic,” Love said.
“Twenty-four percent between the best and worst since 2011,” he said. “Nineteen percent difference just last year alone.”
This is why the key to commodity ETFs is for investors to know what they hold.
“Depending on what products they hold,” Love said, “… they might have performed significantly better or worse than others.”
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