Commodities for the Long Run

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
AlohaJoe
Posts: 5082
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Commodities for the Long Run

Post by AlohaJoe » Wed Nov 30, 2016 4:11 am

The title is obviously a play on Siegel's best selling book, Stocks for the Long Run...

They use a brand-new data from 1877 (starting with lard, oats, and wheat) to 2015 to look at the place of commodities in a portfolio. I'm sad to learn that lard has had a negative return over that 100+ year period.

http://www.nber.org/papers/w22793.pdf

It looks like another collaboration from researchers at AQR. (Kinda impressive that they seem to be doing a lot more of this than any other mob I can think of.)

"We document that commodity futures returns
  • (1) have been positive on average
  • (2) vary significantly across business cycles, inflation episodes, and periods of backwardation versus contango
  • (3) are driven mostly by variation of spot returns and therefore closely linked to the underlying commodity spot market
  • (4) perform well during inflation cycles and provide more return in backwardated states; and
  • (5) display low correlation with stocks and bonds.
These longrun stylized facts imply that commodity futures can add value to a diversified portfolio from an asset allocation perspective"

I remember a few years ago there was a lot more excitement around commodities in portfolios. In the appendix they show the benefit of adding a 10% allocation to commodities. I wonder if we'll see commodities come back in favor with more posts on Bogleheads someday?

User avatar
sunnywindy
Posts: 441
Joined: Sat Jan 18, 2014 4:42 pm
Location: Wilmington, NC

Re: Commodities for the Long Run

Post by sunnywindy » Wed Nov 30, 2016 8:22 am

I have owned one commodity fund (Harbor Funds - HACMX) and I lost money on it (I'm still glad I sold it or the damage would have been much worse).

The problem I see with commodities is that if you don't buy low, you will not make money. There are other big problems, too, with contango/backwardation, etc... that make the asset class hard to own. Stocks and bond funds, at least, pay a dividend, so it's much harder to really goof up. Not so with commodities.

However, I still follow the commodity fund trends and in the last few years, there have been three or four ETF's that have come out that are interesting:
1. Wisdom Tree Continuous Commodity (GCS)
2. US Commodity Index Fund (USCI) (I like this one the most)
3. Elkhorn Fundamental Commodity Strategy (RCOM)
4. iShares Commodity Select Strategy (COMT)

I haven't read the paper you cite, but for the long run, I am still dubious about owning the asset class.
Powered by chocolate!

User avatar
David Jay
Posts: 7501
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Commodities for the Long Run

Post by David Jay » Wed Nov 30, 2016 9:34 am

Commodities DO provide diversification, but they have no real growth (no profits, no interest, etc.) so in a long-term portfolio they serve the purpose of insurance, not investment.

In a long term portfolio, at least TIPs pay a small return above inflation.

If you don't trust businesses (stock market, corporate bonds) and don't trust governments (treasury products), I guess you are down to Commodities.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

asif408
Posts: 1838
Joined: Sun Mar 02, 2014 8:34 am
Location: Florida

Re: Commodities for the Long Run

Post by asif408 » Wed Nov 30, 2016 9:56 am

Here's a forum post worth reading if you want to get into the nitty gritty of CCFs: viewtopic.php?t=128797. I'm personally not a fan of them and prefer the commodites producers because I don't have to understand roll yield, backwardation/contango, spot prices, etc.
AlohaJoe wrote:I remember a few years ago there was a lot more excitement around commodities in portfolios. In the appendix they show the benefit of adding a 10% allocation to commodities. I wonder if we'll see commodities come back in favor with more posts on Bogleheads someday?
There is always more excitement when something has done well recently. Give them a few years of barn burning performance and you'll see more posts here. There were tumbleweeds in the precious metals equities space until earlier this year, and now you see a lot of posts asking why anyone should own any international stocks. Returns go in cycles, and no one can accurately predict them with any long-term reliability.

Topic Author
AlohaJoe
Posts: 5082
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: Commodities for the Long Run

Post by AlohaJoe » Wed Nov 30, 2016 10:03 am

David Jay wrote:Commodities DO provide diversification, but they have no real growth (no profits, no interest, etc.) so in a long-term portfolio they serve the purpose of insurance, not investment.
This statement seems to be at odds with the central claim of the paper, which I'll quote again
Commodity futures index returns have been positive and significant since 1877.
They show an mean return of 4.8%.

I'm not sure why using (or not using) commodities has anything to with trust; I don't follow the point.

Topic Author
AlohaJoe
Posts: 5082
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: Commodities for the Long Run

Post by AlohaJoe » Wed Nov 30, 2016 10:05 am

asif408 wrote:I'm personally not a fan of them and prefer the commodites producers because I don't have to understand roll yield, backwardation/contango, spot prices, etc.
I'm the same; I barely understand bonds :wink: ; but I don't have to want to invest in something to find a paper interesting.

User avatar
David Jay
Posts: 7501
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Commodities for the Long Run

Post by David Jay » Wed Nov 30, 2016 11:58 am

AlohaJoe wrote:
David Jay wrote:Commodities DO provide diversification, but they have no real growth (no profits, no interest, etc.) so in a long-term portfolio they serve the purpose of insurance, not investment.
This statement seems to be at odds with the central claim of the paper, which I'll quote again
Commodity futures index returns have been positive and significant since 1877.
They show an mean return of 4.8%.
I don't follow your objection to what I wrote. Please explain how commodities grow.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 11:55 pm

Re: Commodities for the Long Run

Post by lack_ey » Wed Nov 30, 2016 12:10 pm

David Jay wrote:
AlohaJoe wrote:
David Jay wrote:Commodities DO provide diversification, but they have no real growth (no profits, no interest, etc.) so in a long-term portfolio they serve the purpose of insurance, not investment.
This statement seems to be at odds with the central claim of the paper, which I'll quote again
Commodity futures index returns have been positive and significant since 1877.
They show an mean return of 4.8%.
I don't follow your objection to what I wrote. Please explain how commodities grow.
First of all, the paper is about commodities futures, so "commodities" in this context is understood in that way and not about the underlying. In that sense if nothing else there is "growth" from investing the collateral in the same sense that bonds grow because that's what's happening. Or sometimes/frequently from rolling the futures contracts. In any case I think you should consider price return as growth but I guess you don't accept that.

A reasonable and I think a practical understanding of growth from an asset allocation perspective is return, which is how AlohaJoe answered.

In general I will more broadly say that I disagree with classifying assets as investments or not-investments based on whether something has cash flows or some idea of "real growth." The total portfolio behavior is what you should care about, not the individual components, and this system does nothing to inform a decision about what weighting might be appropriate (zero is an option). You shouldn't start off considering it some separate category.

User avatar
Portfolio7
Posts: 716
Joined: Tue Aug 02, 2016 3:53 am

Re: Commodities for the Long Run

Post by Portfolio7 » Wed Nov 30, 2016 12:47 pm

I don't invest in commodities except indirectly, my thoughts on that are:

The long term return/risk characteristics appear unexciting based upon the data I've seen, in particular the last 40 years or so. Going back to 1877 or whatever seems like data mining of a sort.

The Asset Allocation reading and investigation I've done. I haven't come across a situation where adding commodities actually appears to optimize a portfolio (there always seems to be a better way to reach my return/risk objectives.)

I have a 10% allocation to Emerging Markets. EM tends to have a strong exposure to commodity prices. I figure that's enough exposure in my portfolio. Plus, I prefer to invest in a stock (that is part of a value-add process), vs a commodity (which is inert in that respect.)

I think of commodities as speculative assets, rather than investment assets. Just my 2 cents.
"An investment in knowledge pays the best interest" - Benjamin Franklin

azanon
Posts: 2633
Joined: Mon Nov 07, 2011 10:34 am

Re: Commodities for the Long Run

Post by azanon » Wed Nov 30, 2016 12:58 pm

Portfolio7 wrote:I haven't come across a situation where adding commodities actually appears to optimize a portfolio (there always seems to be a better way to reach my return/risk objectives.)
Backtested, it does. There's just no way around it. You can simulate it at either portofliocharts or portfoliovisualizer.com, and it's not difficult at all to discover portfolios where both return increased and SD decreased due to the addition of commodities to a portfolio.

Now will the benefit continue in the future? That's the unknown. But for the past, that is definitely known; it helped. There's no reason to get into opinion about the past because that can actually be looked up.

Most likely, take you way to reach risk/return (whatever it is), then add 5-10% commodities. You probably just further reduced the risk, and likely improved the expected return.

itstoomuch
Posts: 5343
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: Commodities for the Long Run-

Post by itstoomuch » Wed Nov 30, 2016 1:08 pm

no, No, NO!
In a weak moment, this summer, I bought 200IAU@13, taxable. :oops: :x :annoyed
also bought 2015, some solar. Never bet on the Sun. :annoyed In my case, It will never rise (from bankrupcy). :oops:
Let ADM, XOM, ED, etc, make the commodity bets.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

longinvest
Posts: 4092
Joined: Sat Aug 11, 2012 8:44 am

Re: Commodities for the Long Run

Post by longinvest » Wed Nov 30, 2016 1:27 pm

AlohaJoe wrote:I remember a few years ago there was a lot more excitement around commodities in portfolios. In the appendix they show the benefit of adding a 10% allocation to commodities. I wonder if we'll see commodities come back in favor with more posts on Bogleheads someday?
AlohaJoe,

You're a little late to the party. Now that PIMCO Commodity Real Return Strategy fund (PCRIX) has proved to be everything it was said not to be, its promoters have moved to promoting more interesting factors. :wink:
Last edited by longinvest on Wed Nov 30, 2016 1:39 pm, edited 1 time in total.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW

longinvest
Posts: 4092
Joined: Sat Aug 11, 2012 8:44 am

Re: Commodities for the Long Run

Post by longinvest » Wed Nov 30, 2016 1:32 pm

For anyone interested in commodities, here's some interesting reading:

The Great Commodities Debate
Rick Ferri and Larry Swedroe battle it out with their opposing views on using commodities in a well diversified portfolio
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW

Wakefield1
Posts: 1059
Joined: Mon Nov 14, 2016 10:10 pm

Re: Commodities for the Long Run

Post by Wakefield1 » Wed Nov 30, 2016 1:35 pm

They're for traders. Market timers.
Better know what you are doing. Over my head.
Not for me (unless I want to bury some gold in my backyard)

Topic Author
AlohaJoe
Posts: 5082
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: Commodities for the Long Run

Post by AlohaJoe » Wed Nov 30, 2016 10:34 pm

azanon wrote:
Portfolio7 wrote:I haven't come across a situation where adding commodities actually appears to optimize a portfolio (there always seems to be a better way to reach my return/risk objectives.)
Backtested, it does. There's just no way around it. [...]
Most likely, take you way to reach risk/return (whatever it is), then add 5-10% commodities. You probably just further reduced the risk, and likely improved the expected return.
Agreed, most of the papers I've read seem clear that the benefit is there, at least relative to a 60/40 portfolio of the S&P 500 and intermediate bonds.

The problem I have is that each paper only compares their pet thing to a very vanilla portfolio. So this paper says you should add 10% commodities. And this other one say 10% corporate bonds. And this other says 10% REITs. And don't forget about...eventually you've got 180% of your portfolio on all these things. :shock:

It would be nice to see an updated, holistic look at all this new research. After all, maybe commodities isn't useful in a portfolio if I've already got emerging markets bonds and international REITs? (Which was something alluded to above.)

Day9
Posts: 826
Joined: Mon Jun 11, 2012 6:22 pm

Re: Commodities for the Long Run

Post by Day9 » Wed Nov 30, 2016 11:33 pm

Adding a splash of commodity futures (say 5%-10% of equity allocation) while simultaenously increasing the duration of your bond portfolio can increase expected return while lowering risk.
I'm just a fan of the person I got my user name from

lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 11:55 pm

Re: Commodities for the Long Run

Post by lack_ey » Thu Dec 01, 2016 12:49 am

Link to the paper on SSRN:
https://papers.ssrn.com/sol3/papers.cfm ... id=2856435

The biggest contribution here is to extend the dataset backwards, looking at older data, and provide a perspective on some of the points made previously in the literature, particularly the famous Forton and Rouwenhorst (2006) that noted "equity-like returns" and the more skeptical Erb and Harvey (2006). Obviously there are potentially some data issues with figures that old and there is a question of how relevant it might be. But more data can help.

Following with prior precedent they construct equal-weighted hypothetical portfolios of commodity futures. (They also look at equal risk-weighted portfolios, but results and conclusions are much the same as for the equal-weighted.) For an individual investor, directly investing in commodity futures is a bit unwieldy based on contract size and the need for diversification, so most would use a fund, which would entail costs and an ER, a drag relative to the performance noted in studies like these.

Here's a look at the cumulative returns over time:
Image

Here the returns in different conditions are examined:
Image
Low inflation is defined as below the full-period mean; high is above. What's shown is excess average (arithmetic mean) return over cash. Because of the volatility, that 4.8% for the full sample is 3.3% in geometric mean terms. Recall that cash slightly beat inflation over the full period so that's a respectable real return.

Big difference between the different regimes: backwardation vs. contango, high vs. low inflation, expansion vs. recession. Interestingly the beta with bonds is not very negative under any of the conditions. But that is a large number of months for each; many justify commodities as a hedge for inflation shocks and those periods are rarer than any of these broader categories. Also note that there's a positive beta with stocks, just not a large one there either. So much for claimed negative correlation with stocks. On the flip side, those expecting commodities to crash every time stocks do, like they did in the financial crisis, may not be right either.

As noted elsewhere, excess spot return seems to be kind of negatively related with interest rate adjusted carry return. It holds for the alternate decomposition, not shown here, of spot return vs. roll yield.

I'm not sure what you might have expected, but the number of months of contango and backwardation are kind of similar, maybe not an obvious result based on what you see of some studies over periods that may be heavier in one (particularly the pro-commodities looks that might have focused more on the backwardation periods). And there were positive returns in excess of cash on average, even under the contango months, just lower than when in backwardation.

Some results when integrated in a portfolio:
Image

A 10% allocation to commodities based on this history would have improved a 60/40 portfolio's Sharpe ratio by... 0.03. Before costs. Actually, notice how the bond Sharpe ratio is probably lower than you're used to seeing. Anyway, I think this table mostly speaks for itself.


All in all, I don't think this changes the mind of those of the world-has-changed, skating-where-the-puck-was, financialization-killed-it school of thought. After all, what does extending backward for more even-really-older data really say? On the other hand, I don't agree totally with that line of argument, and I think what we have here is a broader look at commodities futures under a wider range of conditions, which is not a bad thing.

Personally I don't see any particularly compelling evidence that one should be drastically offended or scared off by commodity (futures) allocations in Vanguard's Managed Payout fund or in some target retirement series funds from others. Also I don't see much strong, compelling evidence for portfolio inclusion for a retail investor.

Conclusion: ¯\_(ツ)_/¯

heyyou
Posts: 3597
Joined: Tue Feb 20, 2007 4:58 pm

Re: Commodities for the Long Run

Post by heyyou » Thu Dec 01, 2016 2:40 am

This is the problem.
Now that PIMCO Commodity Real Return Strategy fund (PCRIX) has proved to be everything it was said not to be
My shares might have done okay except there was significant oil price deflation (negative roll on the futures), and interest rates fell (less income from the collateral), and the pro futures traders could research to see when PIMCO needed to roll its massive futures holdings, all contributing to shrink share values. PIMCO has done a two to one split to improve the appearance of the share price which was a third of the initial 2002 issue price. Would that split have caused the fund ER to double to its current .74%?
PIMCO's commodities futures fund PCRIX (from the annual report March 2016)
RETURNS
1 year -20.3%
5 year -13.7%
10 year -4.3%
since fund inception June 2002
+2.3%
NET ASSETS
03/2014 $14 billion
03/2015 $10 billion
03/2016 $ 5 billion

Post Reply