One of the points I stress in my book is how commodities are not really a wise asset class to allocate assets to for long periods of time. History has shown us that commodities generate poor real, real returns over the long-term. But we don’t have only history on our side. It makes perfect sense that commodities aren’t good long-term performers because they’re huge cost inputs in the capital structure. So they tend to have a very high correlation with inflation.
It’s interesting to look at commodity trading exchanges where these financial products were created primarily as hedging products and slowly became trading vehicles. As a hedging vehicle commodities often make a lot of sense. But as a long-term allocation they make no sense.
It’s my opinion that commodity investing has become somewhat of a fad. As some people have tried to add forms of diversification to portfolios to add some non-correlation they’ve tilted towards commodities. This became a hot selling idea for Wall Street firms who could create products that invested in commodities. And in my opinion, the foundation of this thinking was never very sound as it made no sense to allocate assets towards commodities in the first place.
Anyhow, we’re now seeing a massive supply glut in commodity ETFs and so the death of the commodity ETF has begun. That’s a good thing. Commodities in a portfolio are often diworsification. That is, there’s a level where adding too many assets and trying to get too fancy can be detrimental. I hope retail investors begin to shun commodity ETFs en masse. That way hey’ll be transferring a lot less of their money into the pockets of financial engineers.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.