By Conor O’Driscoll
In uncertain times, we hear investment ideas from all walks of life. In this current period of volatility, commodities are often proposed as alternatives to equities. Friends or family may have asked you about a variety of commodities and if an investor should own them. We thought this would be a good time to share our thoughts on this subject.
Commodities are a sizable chunk of the financial market and for some investors it can make sense to incorporate them into their asset allocation. There are a couple of potential strategies and they each have a different rationale.
A basket of diversified commodities Some investors believe because commodities are critical inputs to the economy (eg. copper, lumber, oil, etc.), getting broad exposure can help diversify a portfolio away from stocks.
Precious metals These are commonly used as a store of value (eg. gold, silver, platinum, etc.). Some investors hold precious commodities due to their low correlation with equities.
A commodity which has taken a steep decline in price This is a trade based on the belief that commodity prices will return to their long-term average.
There are many factors to take into consideration when contemplating investing in commodities, however:
1) Commodity investing incurs high fees and expenses
Commodities must be stored in secure locations (generally vaults) and they need to be insured (eg. against theft), which can be quite expensive. While they are incurring these charges, they do not generate income to offset the expense, so the investor must bear this expense as either depletion of invested capital or out of pocket.
2) The strategies do not always work as intended
Commodity markets tend to be volatile and highly unpredictable. The theoretical grounding behind a strategy may be sound, but still fail to achieve its objectives when you need it most.
Correlations increase in times of market stress, market crashes tend to hit most asset classes at the same time (including commodities).
Sometimes prices that decline to historically low levels continue to fall, as highlighted by recent movements in oil prices. In 2020, the West Texas Intermediate fell from $63pb in January to $44 in February, then to $14 in March, before bottoming at negative $36 in April.
3) The fundamentals of commodity markets are extremely complex
Ascend focuses our investments into companies and funds that we believe are relatively straightforward to understand. The dynamics driving commodity prices tend to be incredibly technical and varied. Both supply and demand can be impacted by a variety of factors that happen at the local and global level and can be incredibly difficult to foresee. One possible example would be a mining strike – this could have a definite impact on the supply of that metal but very few people have the resources to track global mining labor relations and would be taken almost completely unaware.
The marketplaces at which these commodities can be bought and sold tend to be much more complex than equity markets. One exception to this comes in the form of physical precious metal, but this comes at the cost of buying and selling from individual traders that may incorporate eye-watering markups.
There are many viable investment strategies that incorporate commodities which investors may consider. However, it is crucial to weigh the pros and cons before deciding to invest. These strategies tend to be expensive, complicated, and reality does not always match with the theory behind them. Furthermore, the fundamentals driving commodity markets tend to be extremely complex and difficult to read. Ascend builds your portfolios with companies that we believe have great, easy to understand business models and fundamentals (on top of strong balance sheets).
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The report herein is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here reflect the judgment of the author as of the date of the report and are subject to change without notice. Any market prices are only indications of market values and are subject to change. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Past performance is no guarantee of future results.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC. Ascend Advisory Group is a separate entity from WFAFN. ©2020 Wells Fargo Clearing Services, LLC. All rights reserved.