Whatever happened to the commodities miracle?

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CULater
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Whatever happened to the commodities miracle?

Post by CULater » Fri Oct 18, 2019 3:07 pm

I remember the Great Debates between Larry and Rick on this topic and wrestling with the decision to invest in commodities or not. I chose not, even though the arguments in favor seemed compelling.
The Holy Grail of portfolio management is finding an asset or strategy that has high returns with low correlations to standard portfolio holdings like stocks and bonds. In the mid-2000s, many investors were led to believe they found such an asset in commodities.
Here's how it turned out:
Image

Who knows what will happen in the future? Sometimes it just takes a long patient time of tolerating "tracking error" for a novel investment strategy to eventually pay off. Or, the novel investment strategy may never eventually pay off. Therein lies the risk.
The lifecycle of a novel investment strategy looks something like this:
> Early investors earn higher returns through a first mover advantage in an unproven strategy.
> Academic research papers highlight the strategy in detail and make it sound too good to be true.
> Wall Street creates a bunch of products to take advantage of said research.
> Retail and institutional investors pile in after all of the huge gains have likely already been extracted.
> Rinse and repeat.
https://awealthofcommonsense.com/2018/0 ... ent-idea/
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afan
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Re: Whatever happened to the commodities miracle?

Post by afan » Fri Oct 18, 2019 5:11 pm

I am not sure the academic papers made this sound too good to be true. That was more on the marketing side of investment advisors. There was excellent evidence that the returns about match inflation. So it had to be dressed up to look like something investors should want.
After the hard reality came down, the excitement moved to other alternative investments.It went from "everyone should buy CCFs" to "everyone should buy these particular multifactor active mutual funds" to "everyone should buy these lending and reinsurance active mutual funds". All of the must buy funds had nose bleed expense ratios, required payment of investment advisory fees to someone in order to get into them and most were appallingly tax inefficient. When they implode there will be something else that everyone should buy.

Or accept that markets are efficient. Pay near zero net expense ratios, zero investment advisory fees and put your money in a handful of broad cap weighted index funds. Client would be better off. Bad news for investment advisors, since no one would buy their services.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

afan
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Re: Whatever happened to the commodities miracle?

Post by afan » Fri Oct 18, 2019 5:24 pm

But you were not supposed to look at the performance of the asset in isolation. One was supposed to add it to a portfolio of stocks and bonds, exploiting the low correlation with both to improve risk adjusted return.

According to portfolio visualizer, if you added a 10% allocation to PCRIX, one of the funds that everyone needed, to a 60/40 VTI/BND portfolio the result from 2007 to 9/2019 would have been.
LOWER overall return to the portfolio with PCRIX than without
HIGHER standard deviation for the portfolio with PCRIX than without
LOWER Sharpe ratio for the portfolio with PCRIX than without

All returns were gross of the advisor fees.
Actual returns to the sad souls who paid someone to do this to them would have been worse.

PV does not mention this, but HIGHER taxes if held in a taxable account.
Except for those minor quibbles, it worked great.

Cap weighted index funds.
Near zero net expense ratios.
No investment advisor fees.
Get on with life.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

TaxingAccount
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Re: Whatever happened to the commodities miracle?

Post by TaxingAccount » Fri Oct 18, 2019 5:26 pm

.....
Last edited by TaxingAccount on Tue Nov 05, 2019 1:37 pm, edited 1 time in total.

retired@50
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Re: Whatever happened to the commodities miracle?

Post by retired@50 » Fri Oct 18, 2019 5:26 pm

To me, the miracle is that advisers suckered as many people as they did into a lousy investment. The correlation stuff may seem fascinating, but if the long term average return isn't different than zero, what's the point for a buy and hold investor. The only way to make any money at commodities is to be a successful market timer. Good luck with that... Regards,

JBTX
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Re: Whatever happened to the commodities miracle?

Post by JBTX » Fri Oct 18, 2019 5:33 pm

There was a confluence of events

- the recession dampened demand across the board and worldwide demand never fully recovered.
- as to oil and gas, fracking happened. Oil is a big part of commodities indices.
- while China continues to grow, their rate of growth has subdued and infrastructure construction slowed.
- between ethanol and supply shocks/weather events etc crops did well in early / mid 00s. That stabilized, and higher demand usually results in more production and price reversals.

heyyou
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Re: Whatever happened to the commodities miracle?

Post by heyyou » Fri Oct 18, 2019 7:14 pm

The strategy backtested very well after a long period of high inflation. Oops, in the following, low inflation period, it didn't work well at all, for the next dozen years, so far. The lesson is that there are always more risks than the familiar, obvious ones. Expect the marketers to always, soon offer something that looks just like what you always wanted, with risk and reward then disagreeing with your recency-biased perceptions.

One of the characters in a Shakespeare play said, "The fault, dear Brutus, lies not in our stars, but within ourselves" about 400 years ago, and the current behavioral psychologists agree on that.

afan
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Re: Whatever happened to the commodities miracle?

Post by afan » Fri Oct 18, 2019 7:41 pm

As for correlations
VTI vs BND -0.02, effectively zero
BND vs PCRIX 0.14, low but not zero
VTI vs PCRIX 0.54, not much of a diversifier

It did not make sense and it did not work.
CCF managers and investment advisors made a lot of money on the commodities play.

Has anyone seen any estimates of how much money, in aggregate, investors lost on this boondoggle?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Nicolas
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Re: Whatever happened to the commodities miracle?

Post by Nicolas » Fri Oct 18, 2019 7:50 pm

I remember at the time, in 2005, the experts were saying we were at the start of a commodity “supercycle” that could last twenty years. They talked a good talk but it didn’t happen.

am
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Re: Whatever happened to the commodities miracle?

Post by am » Sat Oct 19, 2019 1:19 pm

Seems like every time people here start deviating from the 3 funder or jumping on the performance bandwagon , whether it’s commodities, gold, qspix, etc. it eventually becomes a disappointment. Investing is simple but not easy is right. Why can’t people be satisfied with a decent return from the 3 funder?

Chicken Little
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Re: Whatever happened to the commodities miracle?

Post by Chicken Little » Sat Oct 19, 2019 1:36 pm

So you're saying that commodities look like a good value right now?

Are there any solid vehicles for the retail investor to tap into this opportunity? Reasonable costs, tracking etc?

slick_dealer_05
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Re: Whatever happened to the commodities miracle?

Post by slick_dealer_05 » Sat Oct 19, 2019 2:12 pm

Too much supply from shale oil, not much demand growing due to electric cars, short commodities

Jebediah
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Re: Whatever happened to the commodities miracle?

Post by Jebediah » Sat Oct 19, 2019 11:57 pm

afan wrote:
Fri Oct 18, 2019 7:41 pm
As for correlations
VTI vs BND -0.02, effectively zero
BND vs PCRIX 0.14, low but not zero
VTI vs PCRIX 0.54, not much of a diversifier

It did not make sense and it did not work.
CCF managers and investment advisors made a lot of money on the commodities play.

Has anyone seen any estimates of how much money, in aggregate, investors lost on this boondoggle?
I'm not sure I understand. Are you saying you do or do not like ccfs?

afan
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Re: Whatever happened to the commodities miracle?

Post by afan » Sun Oct 20, 2019 3:56 pm

Jebediah wrote:
Sat Oct 19, 2019 11:57 pm
afan wrote:
Fri Oct 18, 2019 7:41 pm
As for correlations
VTI vs BND -0.02, effectively zero
BND vs PCRIX 0.14, low but not zero
VTI vs PCRIX 0.54, not much of a diversifier

It did not make sense and it did not work.
CCF managers and investment advisors made a lot of money on the commodities play.

Has anyone seen any estimates of how much money, in aggregate, investors lost on this boondoggle?
I'm not sure I understand. Are you saying you do or do not like ccfs?
It did not make sense and it did not work.
CCF managers and investment advisors made a lot of money on the commodities play.

Has anyone seen any estimates of how much money, in aggregate, investors lost on this boondoggle?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

DonIce
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Re: Whatever happened to the commodities miracle?

Post by DonIce » Sun Oct 20, 2019 4:14 pm

A stock represents part ownership in a corporation whose point is to make money and eventually pay out profits to shareholders. This is an asset that should generate positive return in the long run, though there is always the risk of the company doing poorly.

A bond represents a debt from a government or corporation that pays interest. This is also an asset that should generate positive return in the long run.

A commodity, on the other hand, is just a lump of material. All it does is sit there. It doesn't generate any returns, no matter how long you wait. In fact, the longer you wait, the less it will be worth, since you are paying someone to store and handle it for you.

Most commodities do not even keep up with inflation in the long run, since economic and technological progress makes basic materials ever more abundant and cheaper to extract/produce. It may be possible to strike it rich by investing in a material that suddenly becomes scarce in the future, but that is like trying to pick an individual stock. Holding a broad basket index of commodities has negative expected return. As for anti-correlation with stocks and bonds, consider that during economic recession both production and consumption are usually depressed, reducing the demand for commodities. In the past, some recessions were caused by spiking oil prices, but this is far from certain to repeat in the future.

Gold is seen by many as a special case because of its rarity and its unique significance in human social and cultural history. It has certainly been one of the best performing commodities. However, its continued viability is far from guaranteed. Societal and cultural preferences can change. Cost-effective methods of synthesizing gold using nuclear reactions may be developed. Asteroid mining might become a thing, drastically increasing supply. Governments have outlawed the trade or possession of gold in the past.
Last edited by DonIce on Sun Oct 20, 2019 4:17 pm, edited 1 time in total.

illumination
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Re: Whatever happened to the commodities miracle?

Post by illumination » Sun Oct 20, 2019 4:17 pm

The inflation a lot of people expected just never really showed up.

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nisiprius
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Re: Whatever happened to the commodities miracle?

Post by nisiprius » Sun Oct 20, 2019 5:10 pm

illumination wrote:
Sun Oct 20, 2019 4:17 pm
The inflation a lot of people expected just never really showed up.
That wasn't supposed to be necessary.

To be fair, I don't think it "commodities" (collateralized commodities futures) were ever portrayed as a "miracle."

They were portrayed as a dandy uncorrelated asset that was almost a sure thing to improve traditional retirement portfolios--not miraculously, but enough to justify a recommendation almost everyone should have some. And there was enough consensus to get them accepted and e.g. included by Fidelity in its mainstream line of Freedom target-date funds, with allocations of around 10%.

I think the big take-home message is low correlation with stocks should be regarded as icing on the cake, but no more than that. It's enough to justify an asset class if the asset class isn't a decent investment in itself. In theory, there can be lousy investments that nevertheless improve the portfolio as a whole, but in practice I personally will stick to investments that I think are decent all by themselves.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Elysium
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Re: Whatever happened to the commodities miracle?

Post by Elysium » Sun Oct 20, 2019 5:19 pm

nisiprius wrote:
Sun Oct 20, 2019 5:10 pm
It's enough to justify an asset class if the asset class isn't a decent investment in itself. In theory, there can be lousy investments that nevertheless improve the portfolio as a whole, but in practice I personally will stick to investments that I think are decent all by themselves.
In theory. That is the key word. I am yet to see an otherwise lousy investment improving the portfolio as a whole. I always liked Rick Ferri's logic in this regard, both then and now, stocks and bonds produce something, commodities do not, therefore they do not merit inclusion. Stocks produce earnings and dividends, bonds provide interest income, even junk bonds promise something, commodities are for consumption, they do not have earnings, dividends, or interest.

Dead Man Walking
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Re: Whatever happened to the commodities miracle?

Post by Dead Man Walking » Sun Oct 20, 2019 11:21 pm

I hope that Larry Swedroe responds to your inquiry. Perhaps one of his admirers will respond with a link to his current justification for CCFs as part of a diversified portfolio.

DMW

james22
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Re: Whatever happened to the commodities miracle?

Post by james22 » Sun Oct 20, 2019 11:31 pm


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whodidntante
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Re: Whatever happened to the commodities miracle?

Post by whodidntante » Sun Oct 20, 2019 11:52 pm

am wrote:
Sat Oct 19, 2019 1:19 pm
Seems like every time people here start deviating from the 3 funder or jumping on the performance bandwagon , whether it’s commodities, gold, qspix, etc. it eventually becomes a disappointment. Investing is simple but not easy is right. Why can’t people be satisfied with a decent return from the 3 funder?
I mean, sure, as long as it goes up anything looks really smart. But it still comes down to taking risk in exchange for a positive expected return. Are you familiar with the sheepdog thread? Buy and hold is out of reach for some people, after they witness 30%, 40%, or 50% of their hard-earned net worth go through a shredder. So you get this quest for different betas and Larry's book "Reducing the Risk of Black Swans." But they are also different betas when the market factor is doing great.

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Re: Whatever happened to the commodities miracle?

Post by CULater » Mon Oct 21, 2019 12:04 pm

james22 wrote:
Sun Oct 20, 2019 11:31 pm
viewtopic.php?t=244087
That's an interesting and informative thread. A couple quick takeaways for me: Larry suggests one of the benefits of commodities is a negative correlation to long treasuries, which allows you to go out to longer durations in your portfolio allocation. Indeed he is correct, as the correlation has been -0.46 since 2009. But unfortunately, that high negative correlation was because CCF returns have been massively negative over that period. What good is a diversifying asset that diversifies because it is consistently losing money for you? One might reply that this is the cost of the "insurance" that CCFs provide; but sometimes an insurance product might not be a smart purchase, and each investor will have to decide what role CCF insurance plays in their overall wealth allocation.

Second, Rick Ferri makes the point in the thread that when you choose a portfolio allocation it should be for the long term to benefit. Allocating to commodities (or anything else) should be based on a willingness to hold onto that allocation for 15-20 years through thick and thin. Did anyone who went for commodities 10-15 years ago actually do that? Are there any diehard buy and holders out there now? I don't think Larry has held on either.
On the internet, nobody knows you're a dog.

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