Thinking about adding a 5% position to commodities

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Buster65
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Thinking about adding a 5% position to commodities

Post by Buster65 »

I was thinking about adding a 5% position to commodities through ETF. Was looking at DJP or even better DJCI (lower expense ratio). Its been dead money and pays no dividend but could be a good non correlated to equity's holding if the market goes down. Thoughts on this?
minimalistmarc
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Re: Thinking about adding a 5% position to commodities

Post by minimalistmarc »

5% won't make much difference either way so why bother?
aristotelian
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Re: Thinking about adding a 5% position to commodities

Post by aristotelian »

Most people generally invest in bonds in order to hedge against a bear market in stocks. If you are looking for a hedge, why would you invest in an index that was -39.7% in 2008?
Valuethinker
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Re: Thinking about adding a 5% position to commodities

Post by Valuethinker »

Buster65 wrote:I was thinking about adding a 5% position to commodities through ETF. Was looking at DJP or even better DJCI (lower expense ratio). Its been dead money and pays no dividend but could be a good non correlated to equity's holding if the market goes down. Thoughts on this?
there are huge debates here.

If we get a bear market like the 1970s this will help. If we get a bear market like the 1930s (when commodity prices fell) this will not help. Consider for example the price of oil in the last 3 years-- world economy doing OK, stock markets booming. Oil? Copper has rallied, but it's not looking that healthy.
Jack FFR1846
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Re: Thinking about adding a 5% position to commodities

Post by Jack FFR1846 »

$1600 in Gold 5 years ago would bring you $1200 if you sold today. Stuffing cash into your mattress was a better investment.
Bogle: Smart Beta is stupid
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David Jay
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Re: Thinking about adding a 5% position to commodities

Post by David Jay »

Commodities have no intrinsic growth, it is a zero-sum game. An ounce of silver today is still only an ounce of silver in 10 years.

Bonds pay real interest, stocks have earnings.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
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SmileyFace
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Re: Thinking about adding a 5% position to commodities

Post by SmileyFace »

"The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn't going to do anything for you….it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time."
.... Warren Buffet
PFInterest
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Re: Thinking about adding a 5% position to commodities

Post by PFInterest »

Sounds like a waste.
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David Jay
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Re: Thinking about adding a 5% position to commodities

Post by David Jay »

DaftInvestor wrote:
"The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn't going to do anything for you….it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time."
.... Warren Buffet
nice quote. Consider it to be stolen (and used shamelessly) as of this moment.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
92irish
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Re: Thinking about adding a 5% position to commodities

Post by 92irish »

Echoing all the other comments - not a fan of commodity ETFs. They are expensive, volatile, and all kinds weird risks (cantango anyone?).

If you are seeking an asset class that provides inflation protection in a portfolio and diversification, I'd stick with an allocation to TIPS. That's what I do.
lack_ey
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Re: Thinking about adding a 5% position to commodities

Post by lack_ey »

Those are not ETFs, in case that's what you actually wanted. Those are ETNs, subject to issuer credit risk. In general I think you should probably prefer one of the commodity pools (e.g. DBC, the largest exchange-traded product in the commodity space, though expect a K-1 come tax time) or one of the actual ETFs.

Commodity futures return correlation with equities is period dependent. Sometimes certain underlying economic drivers move both commodities futures and equities downwards, like 2008-2009. Sometimes there's significantly less of a relationship or even they're negatively related. Since 2010, however, correlation of monthly returns with stocks has been in the range of 0.5 or so, which does not look like 0 at all.

What are your views on contango in some of the contracts (particularly energy)? Any ideas about relative weighting between different commodities? Are you looking for a representative slice by production or something else, possibly a little less focused in energy? There are a lot of choices available that do different things. Do you want front-month rolling or are you looking for something else? How carefully or strongly do you prefer DJP or DJCI compared to the other choices available?

What's your sense of the long-term spot return of commodities? What's that relative to the return of commodity futures? What do you expect here? Are you interested in hedging inflation or are you more looking for possibly uncorrelated and hopefully positive returns? What else do you currently own and why?

There are many previous discussions on the merits and I'm not going to flat-out say "no" but I don't think it's ever a good idea unless in the very least you've thought through many of the issues, have realistic expectations, and a coherent vision for integration.
Jiu Jitsu Fighter
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Re: Thinking about adding a 5% position to commodities

Post by Jiu Jitsu Fighter »

I am a fan. However instead of a general commodities fund which usually has a high expense ratio and issues with contango, I'd recommend a gold fund (not futures or mining stocks) such as IAU. You will not find much support for this view on this message board because it doesn't pay interest, in the long-term it only keeps up with inflation, and guess what, you can't eat it!!! That's my favorite. My second favorite is that it is just a shiny rock, and one of these days, people will wake up and figure out that it's worth nothing even though all central banks own it and for inclusion for your country to be included in the Euro, you have to put up a certain percentage of gold.

What naysayers won't tell you is that adding a small allocation increases the Sharpe ratio of most portfolios. Also, it really has no correlation to stocks and a negative correlation to bonds. Prices can spike which provide a great opportunity to rebalance - you could have done so several times during the last decade+. I think people focus on nominal returns instead of real returns. When a fixed instrument pays 1% and the inflation rate is 2%, your real return is a negative 1% even though the instrument pays interest. Furthermore, you can't eat a T-Bill either. You don't need to be a end-of-the-world proponent to benefit from this.
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unclescrooge
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Re: Thinking about adding a 5% position to commodities

Post by unclescrooge »

I second Jiu Jitsu Fighter's comments.

I have a 6% allocation to commodities, and since I'm a slice-n-dicer, it includes a commodity ETN (avoiding the k-1 issue), a gold etf and a gold miners etf.

Many people on this baord will tell you a 3-5% allocation won't make a difference to your returns. However, last year gold miners were up 50%. A 3% allocation to it definitely impacted your returns.
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Re: Thinking about adding a 5% position to commodities

Post by FactualFran »

lack_ey wrote:Those are not ETFs, in case that's what you actually wanted. Those are ETNs, subject to issuer credit risk. In general I think you should probably prefer one of the commodity pools (e.g. DBC, the largest exchange-traded product in the commodity space, though expect a K-1 come tax time) or one of the actual ETFs.
In addition to DBC (PowerShares DB Commodity Index Tracking Fund) there is PDBC (PowerShares Optimum Yield Diversified Commodity Strategy No K-1 Portfolio).
Theoretical
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Re: Thinking about adding a 5% position to commodities

Post by Theoretical »

Pimco's PCRIX is also pretty good, as it uses TIPS to be the collateral for the commodities futures.
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nisiprius
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Re: Thinking about adding a 5% position to commodities

Post by nisiprius »

A detail but an important detail.

1) You would not be adding a position in "commodities" at all. I was going to write that you would be investing in collateralized commodity futures but it turns out that that is not quite right, either.

2) You would not be buying an "ETF."

Image

You would be buying an exchanged-traded note or ETN. If you are not clear on what the difference is, then perhaps you are not ready to make the investment. Some direct quotes from the prospectus:
  • The ETNs are unsecured debt obligations of the issuer, Barclays Bank PLC, and are not, either directly or indirectly, an obligation of or guaranteed by any third party.
  • Investing in the securities will not make you a holder of any commodity or futures contract on any commodity, or any other futures contract relating to the reference assets or their components.
  • Your securities may provide exposure only to futures contracts and may not provide direct exposure to physical commodities.
  • [Perhaps most troubling:] Your investment in securities linked to commodities, commodity futures contracts or an index of commodities or commodity futures contracts will not entitle you to the regulatory protections of the CFTC or any other regulated futures exchange.... An investment in the securities thus does not constitute either an investment in futures contracts, options on futures contracts or in a collective investment vehicle that trades in these futures contracts (i.e., the securities will not constitute a direct or indirect investment by you in the futures contracts), and you will not benefit from the regulatory protections of the CFTC. We are not registered with the CFTC as a futures commission merchant and you will not benefit from the CFTC’s or any other regulatory authority’s regulatory protections afforded to persons who trade in futures contracts on a regulated futures exchange through a registered futures commission merchant.
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Theoretical
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Re: Thinking about adding a 5% position to commodities

Post by Theoretical »

Yeah, post-2008, I wouldn't touch an ETN with a 10 foot pole.
WallStreetPhysician
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Re: Thinking about adding a 5% position to commodities

Post by WallStreetPhysician »

Buster65 wrote:I was thinking about adding a 5% position to commodities through ETF. Was looking at DJP or even better DJCI (lower expense ratio). Its been dead money and pays no dividend but could be a good non correlated to equity's holding if the market goes down. Thoughts on this?
Your stated facts are correct:
-Dead money
-No divided
-Non-correlated with equities

If you have a long-term positive outlook of the market (I'm saying 10-20 years, not 1 year), I wouldn't add commodities. If you want a non-correlated asset class to protect against downturns, use bonds.

-WSP
Theoretical
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Re: Thinking about adding a 5% position to commodities

Post by Theoretical »

I think Commodities do have a small place in the portfolio, but only as part of a portfolio whole.

Before adding them, you really need to consider why you're adding them. Merely adding them due to "non-correlation" won't help you when they do become correlated. For example, long treasuries did amazingly well in 2008 because we were in a deflationary financial panic. However, over the long term, long treasuries tend to have increasing correlation with equities. On the flipside, partly due to the deflationary situation and due to some institutional vulnerabilities, TIPS actually lost money in 2008 (but were a great deal). Commodities got roasted alive in the Financial crisis.

In addition, the cotango risk with energy has made commodities less appealing and somewhat overpriced.

If you're following usual Boglehead strategies to limit the duration of your bonds, you're not going to get that much benefit from your commodities. If, on the other hand, you've got a sizable slug of longer term bonds as a fixed piece of your portfolio or an accumulation of cash to make a down payment, then they might make sense.

You can't treat them as an investment, when its really a hedge/insurance against sudden and unexpected inflation.

In times of low inflation, they'll be a boat anchor to neutral.
In times of deflation/panic, they'll not be a safe haven. In this respect, gold wins here.
In times of political uncertainty, they may be a benefit, depending on the nature of the uncertainty.
In times of unexpected inflation, they'll most likely provide an outsized benefit to the portfolio.

[Edited] Treat them like a hedge, not an investment that you expect to appreciate, which is actually OK if you're willing to appropriately rebalance when its low and when it soars, because they're quite a wild ride. Like any insurance, there's a cost to it, and it's sometimes pretty significant.
Last edited by Theoretical on Sat Mar 25, 2017 2:38 pm, edited 1 time in total.
lack_ey
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Re: Thinking about adding a 5% position to commodities

Post by lack_ey »

Theoretical wrote:They have an expected real return of 0, which is actually OK if you're willing to appropriately rebalance when its low and when it soars.
How do you figure this, and is this a long-term forecast or based on current conditions?

Are you talking futures (if so, front-month rolls? what's the collateral invested in?) or spot price? Actually, do you mean a fund after expenses/costs or the underlying? Most in this space don't have negligible ER.
Theoretical
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Re: Thinking about adding a 5% position to commodities

Post by Theoretical »

Hmm, I think I got that mixed up with gold. So scratch that part - I edited that. Thanks for the heads up.
stlutz
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Re: Thinking about adding a 5% position to commodities

Post by stlutz »

However instead of a general commodities fund which usually has a high expense ratio and issues with contango, I'd recommend a gold fund (not futures or mining stocks) such as IAU
While I'm not a big fan, this is what I would do if you really feel that you must. Unlike other commodities, gold has a pretty limited supply and people who buy it like to hold onto it, giving it potential price appreciation. Long-term, most other commodities go toward zero as better alternatives are found.

And it's also worth re-reading nisi's post. CCFs != commodities. Those are basically a bet that the commodities markets have been unaffected by the financialization of everything, which is not a good bet in my view.
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