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Commodity ETFs have a place in every portfolio, just not a big place.
Of all the investments in the market, the one area that tends to generate the most controversy is commodities. Some long-term portfolio managers insist that the cyclical nature of commodities, along with their high volatility, suggest they have no place in your portfolio. Others, including myself, believe commodities do have a place in a long-term portfolio.
I don’t think you should allocate massive amounts to commodity investments, but there is a reason to have them. Enough studies have been done that show portfolio risk declines somewhat to make me a believer. Yet, I also go with common sense. The world will always consume. It has to. That means that natural resources and commodities will always have buyers. Overall consumption will increase over time as the population increases. So while the short-term may see price fluctuations, we should see long-term price appreciation in commodities.
I would invest using ETFs, so you remain diversified, and keep commodities to less than 5% of your portfolio.
1. PowerShares DB Base Metals (NYSE:DBB)
PowerShares DB Base Metals (NYSE:DBB) is an ETF that tracks the performance of the Deutsche Bank Liquid Commodity Index – Optimum Yield Metals Excess Return. This contains futures contracts on the most frequently used metals – aluminum, zinc and copper. Going with the theory that all of these metals will always have some purpose in human existence, owning a basket of contracts that trades them should do well in the long term. So now you have base metals covered.
Metals can also provide a hedge against inflation since their process tend to increase with the cost of living.
2. ELEMENTS Rogers International Commodity ETN (NYSE:RJI)
ELEMENTS Rogers International Commodity ETN (NYSE:RJI) is more intriguing that an ETF. Instead of actually holding futures contracts, this security is obligated to give you the same return as if you did own the contracts. Rogers is well-diversified, as it contains 35 commodity future contracts, and is rebalanced monthly. Energy is the big play here, with about 45% of holdings allocated to these commodities, with agricultural commodities taking up 32% and the rest consisting of the metals.
ETNs can have what’s called “credit risk”, in that the company that issues it takes all of its value with it if it goes under, meaning its exchange-traded notes could literally go to zero. In this case, however, Rogers is backed by the Swedish Export Credit Corporation, which backs all the notes.
3. Goldman Sachs S&P GSCI Enhanced Commodity Trust ETN (NYSE:GSC)
Goldman Sachs S&P GSCI Enhanced Commodity Trust ETN (NYSE:GSC) tracks what is perhaps the leading index of commodity prices. It is a basket of commodity futures contracts that are weighted by world production, adjusted for futures trading volume, based on the average amount produced from each category over the past five years.
There are 24 such contracts across the five main commodity baskets. Energy represents about 70% of the index, and some 47% is devoted to crude oil. About 15% is allocated to agriculture, of which corn is the largest at 4.9%. Roughtly 6.66% is allocated to industrial metals, of which copper makes up about half. Then comes livestock at about 5%, and precious metals make up 3.33%.
4. ETFS Physical Precious Metals Basket Shares (NYSE:GLTR)
The final category is the ETFS Physical Precious Metals Basket Shares (NYSE:GLTR). The security actually holds physical bullion in the four big precious metals, allocated 54% to gold, 31% to silver, 8% to platinum, and 7% to palladium.
I like the security because it holds the actual precious metals themselves, in vaults over in Europe. They aren’t notes that promise to make delivery, but the actual bullion itself. I also like that this nicely offsets the industrial base metals ETF above.
Commodities are not for everyone, and some will rightly view them more as trading vehicle than long-term holds to earn potentially higher returns…but with higher risk.
Lawrence Meyers does not own any security mentioned.
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