March 20, 2020
Should commodity investors be happy? While most asset classes are reeling from the coronavirus pandemic, commodities have held up better than stocks. Since the S&P 500 index peaked this year on Feb. 19, it has fallen 30%. The popular Bloomberg Commodity Index (BCOM) dropped 20% during the same period.
Investing in commodities isn’t easy, though—and exchange-traded-fund investors are in a tougher spot. Unlike equities, commodity returns tend to be all over the map. In the past year, returns for the 115 commodity ETFs and exchange-traded notes ranged from 12.9% for the Aberdeen Standard Gold ETF (SGOL) to a 75.9% loss for the iPath S&P GSCI Crude Oil Total Return Index ETN (OILNF). With a return spread of 89 percentage points, how is the average investor to choose the right fund?
Even if you whittle down the sector to the 24 broadly diversified commodity ETFs, you still get a wide variance. First Trust Alternative Absolute Return Strategy (FAAR) and the iPath S&P GSCI Total Return Index ETN (GSP) are down 4.9% and 46.2%, respectively, in the past year.
“Investing in the passive indices for commodities is really like throwing a dart,” says Renee Haugerud, founder of commodity investment firm Galtere and manager of the SilverPepper Commodity Strategies Global Macro fund (SPCAX). “It’s not a singular asset class that trends in the same direction, like equities. Each commodity can have singular fundamentals that are diametrically opposed to each other.”
Yet it’s a good time to buy certain commodities. “If you look at the BCOM, we’re below 20-year lows on commodity markets,” Haugerud says. Before the 2008 crash, the BCOM was as high as 240, but is now at 62, she observes. There’s less room for prices to fall during this downturn, even if global growth slows because of coronavirus. Equities, by contrast, are still well above their 2009 lows, so they have a greater potential downside.
Commodity Strategies for Individuals
Commodities have suffered during the long bull market in stocks, but now they could be a good strategy to protect your portfolio on the downside. Commodity funds are a diverse category, and often expensive. Choosing one isn’t easy. Here are some suggestions.
Data as of March 17; three-year return annualized. N/A=Not appicable
Source: Morningstar Direct
Still, Haugerud isn’t bullish on crude oil—often the largest commodity weighting in index funds—despite the recent selloff. Prices were too dependent on the “binary outcome” of OPEC production negotiations, she says. And after the OPEC deal to cut 1.5 million barrels a day of production failed and Saudi Arabia and Russia engaged in a price war, she accurately predicted that oil would fall as low as $20 a barrel.
In the short term, Haugerud is fond of gold as a defensive play for “risk-off” environments from virus fears. Long-term, though, coffee, cocoa, corn, and copper look more promising.
For Haugerud, one sign of an attractive investment is whether or not a commodity is trading below its cost of production, something the standard index ETF or mutual fund ignores.
“Corn is definitely below the cost of production,” she says. Coffee had suffered from the invention of pods, as they require fewer beans to make a cup, but now, “if you have any increase in demand, new K-Cup efficiency isn’t going to make the difference. I think coffee over the next five years is going to probably double.”
Another positive sign is when demand for a commodity outstrips supply. That’s why Haugerud’s also a copper fan: “We’ve seen a huge destocking of copper, with supplies going down.”
The same goes for palladium, which is used in cars’ catalytic converters to reduce harmful emissions. “Currently, worldwide palladium usage is about 500,000 ounces a year,” says financial advisor Lou Stanasolovich, whose Pittsburgh-based firm, Legend Financial Advisors, is one of the largest holders of the Aberdeen Standard Physical Palladium Shares ETF (PALL), according to Morningstar. “There are about 300,000 ounces that are mined every year.”
To play agricultural opportunities, you could buy a single commodity index exchange-traded product, such as the iPath B Bloomberg Coffee Total Return ETN (JO) or the Teucrium Corn fund (CORN). But they’re problematic, since commodities funds generally gain their exposure through futures contracts. Most indexed ETFs buy their futures contracts in a systematic rules-based way that often leads to suboptimal results, as futures prices often fluctuate in nonsystematic ways.
Active management may be the best answer to the commodity conundrum, but it doesn’t come cheap. Haugerud’s SilverPepper fund has beaten 93% of its peers and its Morningstar benchmark in the past five years with less volatility, but it charges a hefty 2% expense ratio. Another benchmark-beating active fund is BlackRock Commodity Strategies (BCSAX), which combines both commodity futures and stocks, but it charges 0.97%.
The most affordable active products tend to be active-passive hybrids. Newcomer Vanguard Commodity Strategy (VCMDX), which launched in June of last year, is intriguing, with its cheap 0.2% fee. It offers exposure to the BCOM, but “the active portion comes in the way that we are going to go about managing the futures contracts within the BCOM,” says Matt Jiannino, Vanguard’s head of Quantitative Equity Product Management. Unfortunately, it has a $50,000 minimum investment.