Commodity Protection
Before money became a form of exchange, humans regularly traded commodities, produce, and valuable possessions. The barter trade practice traces as far back as 6000 BC, making it the oldest mode of transaction.
Today, investors do not need to own the physical commodity to have access to it. Because of financial innovation, anyone can access commodities through commodity funds and commodity ETFs.
Commodity ETFs first appeared around 1998. Derek Horstmeyer, a professor of finance at George Mason University’s business school did a study on all commodity mutual funds and ETFs over that time frame to compare how these assets performed during recessions, namely the recessions of 2001, 2007-2009, and 2020, as compared to non-recessionary periods in the past 25 years.
In the chart above, the blue arrows show how different commodities have performed during non-recessionary times. We can see that physical commodities do slightly better than the funds tracking the commodity as shown by spot price return (i.e. the current price in the marketplace for which the asset can be bought or sold for immediate delivery).
However, there can be meaningful divergences as seen in the difference between oil funds and oil ETFs when compared to the physical commodity return. This is important to note because investors often expect spot price returns from commodities but are realistically unlikely to get them.
Gold is often thought of as a safe haven asset during a crisis, serving as a vehicle to protect your money. This premise can be investigated by looking at commodity returns during recessions as shown by the red arrows.
During an economic contraction, all commodities except gold logged negative returns. While gold produced a positive return, it is not to the magnitude that one would expect — gold funds and gold ETFs eke out a small monthly return of +0.18% as compared to the physical commodity return of +1.30%. Technically, gold did its job of protecting your capital , but not by a particularly meaningful magnitude.
It is important to consider the nuances when including commodities into your investments as realised performance can differ substantially from physical commodity returns, often giving investors a rude shock. There are other important considerations, for example, do commodities give me inflation protection or do they diversify my portfolio? The short answer is that in recent history, it does not seem meaningfully so. However, the devil is in the details and require an understanding of how these instruments work.
As we have written numerous times before, investing does not mean just taking a large position in an asset because it exposes you to high risks. Commodities may play their part, and you would need to ensure that you allocate an appropriate amount relative to your other assets. In this aspect, a properly constructed investment plan is critical.
In the same way that you would rely on a doctor to treat you or a professional mechanic to service your automobile, investors can benefit greatly by working with an adviser — giving you the peace of mind knowing that your plan is in the hands of a professional.
If you would like to learn more about how to construct a resilient and robust investment portfolio that can last the generations, come speak with us, click here to schedule a exploratory chat with us. (Complimentary 30-minutes session)