Last Wednesday, the NYMEX nearby month contract of natural gas popped over 2 per cent and nudged my natural gas exchange traded fund back to the break-even level. I took on the natural gas ETF last May because of the bullish series of higher lows and I thought my portfolio needed some direct commodity exposure.
Did you notice that I used the words portfolio and commodity in the same sentence?
Traditionally that would be a no-no because a portfolio suggests a nest egg of stocks and bonds that represent the shares of large corporations and the debt of credit-worthy corporations, provinces, states and federal governments. Commodities, on the other hand, are deemed to be risky and suitable only for speculators and day traders.
Commodities can best be described as “things” that are components of different categories such as the hard commodities (copper, gold, silver), the soft commodities (cotton, lumber, sugar) and the grains (soybeans, corn, wheat).
Aside from the assumption of risk, the other impediment is the physical challenge of placing a bulky and perishable “thing” into a portfolio. Gold was probably the first commodity to be placed into a modern portfolio because of its infinite shelf life and its acceptance by investors and portfolio managers as a financial asset.
As far as risk is concerned, the reality is that 5,000 bushels of wheat, 80,000 board feet of lumber or 25,000 pounds of copper may carry less risk than many mid- to small-cap corporations. Commodities do not go insolvent and they do not have “earnings surprises,” Commodities do not have accounting and CEO scandals. As far as I know, no commodity has ever become worthless in modern times.
When it comes to valuations, investors can apply both fundamental and technical analysis studies to any commodity. Fundamental studies would focus on supply and demand and technical analysis would focus on trends and turning points
The one emerging theme in support of introducing a commodity component into the portfolio is that today’s portfolio managers and investors are having difficulty in seeking out non-correlated assets.
In other words, equity exposure to Canada, the U.S., Europe and Asia translates into exposure to multiple assets that all do the same thing at the same time. Equity diversification today is impossible, thanks to globalization.
Commodities are one of the few asset classes that do not necessarily have a positive correlation to the global stock markets and the placement of commodities into the portfolio could reduce risk as measured by volatility. The problem to overcome is how to find a practical way to introduce commodities into the portfolio.
One way would be to deal with a commodities broker who would act on your behalf and expose you to the commodity futures market. The problem here is the high maintenance of rolling futures contracts along with the need for the broker to stick within the constraints of the overall portfolio.
Another strategy is to introduce a commodity exchange traded fund (ETF) into the portfolio. The commodity ETF will trade like a stock, but the price will track a specific commodity such as silver, copper, natural gas or crude. A less complex strategy would be to seek out a commodity ETF that gives you exposure to a basket of commodities. This will cut down on the trading and the need to study a dozen separate commodities.
Our chart this week shows the monthly closes of the Reuters/Jefferies CRB index plotted above the monthly closes of the S&P500 stock index. Also known as the CRB, the index is a basket of 19 commodities representing all commodity sectors. According to Jefferies & Company, Inc., the Thomson Reuters/Jefferies CRB Index is designed to provide a liquid and economically relevant benchmark that provides a timely and accurate representation of commodities as an asset class.
Our chart clearly displays how, over the past 10 years, commodities as an asset class have humbled the mighty S&P500. Clearly we need to participate, and my first candidate was the iShares S&P GSCI Commodity-Indexed Trust (GSG), which I rejected because this product is too heavily weighted in energy at almost 70 per cent of the overall commodity basket.
The “old CRB” is now called the Continuous Commodity Index (CCI) and puts a much smaller emphasis on energy and industrial metals and a much larger emphasis on agricultural products. The relevant ETF here would be the GreenHaven Continuous Commodity Index Fund (GCC), which seeks to reflect the performance of the Continuous Commodity Index (the Index).
The Index is a broad-based commodity index consisting of 17 different commodities. I never thought that owning live cattle or lean hogs would be so easy.
Bill Carrigan, CIM, is an independent stock-market analyst.
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