Carrigan: Go ahead, add commodities to your portfolio

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.

Hydro utilities warn of price shock

July 28, 2010

John Spears

An electricity price shock is about to hit – and local hydro utilities are warming up a campaign to tell consumers it’s not their fault.

Householders who haven’t locked in a rate through a retailer can expect to see the price of power jump by up to 16 per cent when their next bill arrives. On top of that, this summer’s hot weather is driving up the amount of electricity that many household are using.

Utilities like Toronto Hydro and Powerstream are already busy getting the message out to consumers that higher bills are on the way.

And the Electricity Distributors Association, which represents local hydro utilities across the province, is sending information packages to members this week advising them how to explain the price jumps as consumers open their bills.

Brian Bentz, who chairs the association, said the next round of electricity bills consumers receive will factor in two big price hikes:

First, the price of power paid to generating companies went up May 1. That will push a typical household’s bill up by 8 per cent, unless it has a fixed-price contract, Bentz said.

Second, the HST is applied to electricity bills from July 1 on – which will push bills up another 8 per cent for all electricity users, whether they have fixed price contracts or not. (Consumers always paid GST on their electricity bills, put previously were not charged PST.)

The price increase will show up as bills go out in the coming months.

Local utilities are especially sensitive to the price increases, because they’re the ones who bill on behalf of all the players in the electricity market, although they get less than 25 per cent of the total revenue.

“We want to be proactive in getting messages out to our consumers in letting them know about this,” Bentz said.

At the same time, the local utilities are trying to point out that most of the money goes to generating companies (a little over half the bill), transmission companies like Hydro One, and for regulatory charges, including the lefty-over debt from the old Ontario Hydro.

A household using a modest 800 kilowatt hours of electricity a month pays just over $100 for electricity, so the basic price increase and the HST alone will push bills up about $16 for those who pay the market rate, and $8 for those on a fixed rate.

“The third item we’re seeing is we’re having a hotter and more humid summer than in 2009,” Bentz said. “The exact impact we don’t know yet.”

But he noted that so far this summer, there have been 11 days when the temperature has topped 30 degrees C, while last summer at this time the temperature had hit 30 on only three days.

That means many consumers are not just paying more for power this summer, they’ll be using more of it.

While the EDA is helping its members get ready for the price increase, some utilities have been taking action on their own.

Powerstream, the utility owned by Barrie, Markham and Vaughan, has been running a $100,000 advertising campaign this summer giving consumers advice on how to limit their electricity use.

Toronto Hydro has sent inserts in its bills reminding consumers that the local utility gets a minority share of the total bill.

The current round of price increases will not be the last ones. Many consumers have found they are paying higher bills as their utility switches them to time-of-use billing, which boost the price of power significantly during peak demand periods, while lowering prices on weekends and overnight.

Further price increase are likely in 2011 as more power from renewable energy sources flows into the system, at higher prices.