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Commodities In Your Portfolio

For over thirty years - roughly 1974-2004 - the S&P 500 trended upward, with the CRB (Commodity Research Bureau) trending down. The CRB is analogous to the Dow Jones Index - a mathematical combination of commodities prices that indicates their movement. It's composed of weighted averages of prices of oil, coffee, gold, wheat, etc. Yet many savvy investors continue to trade in commodities, and many of those do very well. Why is that?

One reason is that indices don't tell the whole story. General trends don't show the detailed, day-to-day price movements that many traders take advantage of to make profits. After all, at the end of the day what matters is the difference you bought and sold for, not the absolute prices.

Another reason is the historical role commodities have played in trading strategies. Since commodities and stock prices tend to move in opposite directions, commodities form part of many intelligent hedging strategies.

Possibly part of the explanation lies in the contrarian stance of many investors. One school of thought argues, plausibly and with historical data support, that you can't make money by following the crowd. In order to profit you have to do what the other guy isn't. That's true within an investment type, and also across different investments.

It's also true that any well-diversified portfolio will have some of just about everything: stocks, bonds, cash and - in some cases - commodities. As part of an overall hedging strategy, and to diversify both risk and income, it's wise to have a bit of everything. As bonds move down, for example, commodities move up. Inflation tends to work on them in opposite directions.

Lastly, it's simply an empirically observable fact that many commodities have been moving up for many years. Oil is probably the most notable example, with precious metals being the typical alleged loser. 'Loser' really is a misnomer, though. The price of gold did peak almost 30 years ago, but after dropping sharply it has remained steady over most of that period, and has trended sharply up the last few years, rising over 40% since 2003.

Some would argue that the price rise for gold will continue for some time to come. Given the latest views of the Federal Reserve on inflation, that may well be true. As with any investment, no one can be sure. If they could, it wouldn't be called speculation.

This much is a good bet, however. The world will continue to consume wheat, oil, gold, coffee and other common commodities. Another truism is that some of those can't be replenished and the more you extract the harder it is to get what remains.

That's certainly true of gold, though with national governments holding the largest stores and with the trend toward liquidating them, it will be under continued price pressure for some time to come. Canada, for example, eliminated all its horded gold over the period 1980-2003.

Oil, too, is likely to be harder to recover. Recovery of North Sea oil peaked several years ago and has been declining ever since. Until and unless radically new technology comes into play, or environmental policies change, the rate of supply isn't likely to increase substantially. Meantime demand is continuing to rise, particularly from China.

All those factors tend to bode well for including commodities as part of your portfolio, at least in the form of ETFs (Exchange Traded Funds). Other mutual funds that focus on commodities are available, as well. And there's an additional advantage to those investments. Some tend to move in the same direction as stocks, not opposite to them.