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Investing Specialists

Sticking With Commodities Despite the Drop

Readers cite diversification, inflation-hedging advantages as reasons to hold on.

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Adding a small slice of commodities has long been seen as a good way to provide diversification to one's portfolio while hedging against inflation. But lately, investors' allegiance to commodities exposure has been put to the test. Plunging oil prices and sagging demand from China have left commodities prices depressed (not to mention commodities investors).

Consider that over each of the past four calendar years the average broad-basket commodity fund has lost money, including a gut-wrenching 18% drop last year. Meanwhile, the stock market keeps chugging along, recording double-digit gains in three of the past four years. Even bonds have outperformed commodities, returning at least 4% three of the past four years.

The opportunity cost of owning commodities in recent years rather than stocks or bonds surely has not been lost on many commodities investors. Yet, there are those who still see value in owning commodities, not only because of their diversification and inflation-hedging properties, but because of their depressed valuations.

Last week, we asked Morningstar readers on our Alternative Investments discussion forum whether they currently own commodities (for example, through a commodities-oriented mutual fund or ETF), and many said they are standing by the asset class. You can read the full discussion here. It includes the following excerpts.

'They Will Eventually Come Back'
Reader garyepperly said he's excited about owning corn, wheat, silver, platinum, and gold due to their current price levels. "They will eventually come back, may be a while," he wrote. "But it's my belief that we'll be rewarded. I'm especially excited about corn at a five-year low. Any little weather event or non-event next spring could be significant."

"I do not own commodities directly, but own some commodity-based stocks and I believe that now may be a good time to buy," wrote meddguy. "I recently bought shares in  Freeport-McMoRan (FCX). It is somewhat diversified (copper, gold, oil) and has dropped in price significantly. I have owned  Canadian Natural Resources (CNQ) and LinnCo (LNCO) for a while, and it has been a painful experience watching them drop. But I believe in the intermediate to long run both companies will do fine."

Many commenters said they see opportunities in energy due to oil's plunge.

"I own energy stocks as part of my overall stock portfolio," said OUInformant. "I limit my risk by limiting my exposure and diversifying. At this time I am buying since energy stocks have dropped so much as a result of steeply declining oil prices."

Others said they invest more generally in commodities through broad-basket funds.

Webapalooza wrote, "My wife and I hold broad-basket commodities (PowerShares DB Commodity Tracking ETF (DBC), GreenHaven Continuous Commodity ETF (GCC)), gold (ETFS Physical Swiss Gold (SGOL), iShares Gold Trust (IAU)), and energy ( Vanguard Energy ETF (VDE)) investments. They amount to roughly 10% of our overall retirement portfolio. With interest rates at historic lows I'm holding them as inflation hedges. When prices decline, I view them as being on sale, so I stock up on more. I will eventually draw them down and invest those funds elsewhere as we approach retirement."

For Peter5, holding 5% of his portfolio in commodities is about sticking with a long-term outlook. "I have a hard time believing that innovation and environmentally friendly policies will beat the high demand for commodities due to increased world population and wealth. I hope so but doubt it," he wrote.

Bgstuhan said he or she invests in a broad-basket commodity ETF for diversification and inflation protection, adding, "Overall, [commodities] serve a similar role in the portfolio as other alternatives but with lower fees than hedge funds, long-short funds, and other expensive alternatives." 

For at least one reader, buffetTheThrid, deciding to invest in commodities took some time.

"Being from Canada, I've had to spend the past 15 years listening to everyone around me (family, television, news) tout the fabulous investment value of commodities as their values skyrocketed (mainly gold and oil)," the commenter wrote. "I never bought any, though, because it all seemed like a China-fueled bubble and not a very safe investment. This week, with commodities now firmly out of favor, I decided to allocate 5% of my retirement money into a commodity ETF."

'They Are Testing My Resolve'
But even among those who have long owned commodities, there were those who continue to do so reluctantly.

Bob07834 wrote, "We own  Harbor Commodity Real Return ST (HACMX) and a small stake in Vanguard Precious Metals and Mining (VGPMX) as part (5%) of a diversified portfolio. Although, with the China slowdown, Bill Gross leaving PIMCO [which runs Harbor Commodity], and a lack of global growth, I'm questioning the wisdom of those choices. ... I knew that commodities were highly cyclical, but they are testing my resolve. Fortunately, I have a long time horizon and will wait it out because now is definitely not the time to sell."

Count gtoerr among those who were hesitant to invest in commodities but who have changed their tune.

"Originally I avoided commodities because I read that they haven't had much of a return over the long run," gtoerr wrote, "but I've since changed my mind and have allocated a fraction of my portfolio to precious metals for purposes of diversification and as a type of currency/financial hedge. I don't buy the argument that they're not an appropriate asset class because they don't generate revenue. Hard assets, almost by definition, are a store of value. As such, they're a good way to balance a portfolio."

Then, there was NYCKid, who sounded somewhat ambivalent about his or her commodities stake.

"As a very long-term (10 to 20-plus years) hedge, I have a small investment in a fund invested in producers of a diverse array of natural resources," wrote NYCKid. "This is based on the unpalatable notion that, over the long haul, we may be on a one-way trip to greater and greater scarcity. I would probably own a little more than I do if I could get over the notion that this is a bet against human ingenuity, and betting against that just makes me feel queasy."

'I Guess I've Given Up on the Asset Class'
Of course, not everyone who responded to our question said they own commodities. Some gave very specific reasons as to why they do not.

Some, including rllucky, simply don't like the fact that commodities don't generate income the way dividend-paying stocks do.

"For my investment objectives, direct investment in commodities is speculative in nature because it requires the ability to accurately predict the dynamics of supply and demand, and that's very difficult," rllucky wrote.

For some readers, poor performance and volatility make commodities a no-go zone.

"I've been burned investing in the roller coaster ride of commodities--mostly on the way down," said Rathgar. "... I am a buy-and-hold investor and commodities seem to be the type of investment you need to get in and out of. I guess I've given up on the asset class."  

Rvandenbrul recalled owning two commodities funds to guard against inflation that never materialized.

"I found the commodity funds too volatile and decided a brief inflation scare a few years ago was not panning out as the Federal Reserve continued its policy of low interest rates after concluding inflation fears were overblown," the commenter said. "Glad I got out before the collapse in commodity prices. I doubt if I will use these funds again."

For rumljo, the problem with investing in commodities was the type of commodity funds he was finding.

"I researched commodity funds years ago and nearly all owned too much precious metals and/or oil," the commenter said. "I wanted commodities (e.g. agriculture, forest, non-precious metals). Bought a T. Rowe Price fund that just treaded water over several years. Now I believe commodities are too uncertain and volatile and that I am not qualified to invest wisely. Stocks and ETFs are hard enough."

Reader Uysses cited legendary investor Warren Buffett's reasons for avoiding gold in explaining why he or she avoids commodities altogether.

"Something that generates zero cash flow is hard if not impossible to value and is therefore a form of speculation, which is not something I care to indulge in as a retiree," Uysses wrote.

Lastly, there was Chief K, who said it's simply too difficult for individual investors to use commodities well.

"Even fund managers who study this issue full-time will be 'behind the curve' too often when compared to the professional buyers (users) and sellers (producers) of the various commodities," he said.

Some comments have been edited for clarity and brevity.

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