A real estate fund would be our top choice for portfolio diversification using a sector fund, even though commodity funds have gained quite a bit of attention. These funds do not generally buy commodities directly, but rather buy derivatives that give their portfolios exposure to fluctuations in the price of commodities such as oil, wheat, metals, and hogs.
Commodities-focused funds are not widely available—only a small number of fund shops offered them as of the middle of 2011. As a stand-alone investment, commodities funds are highly volatile. But when used as a very small piece of a broader portfolio, these funds’ limited correlation with the stock market means they can actually reduce a portfolio’s overall volatility level and potentially improve its returns. However, as shown in later readings, this broad category, at best, keeps pace with inflation; most of the time, its long-term returns are far below inflation and T-bills.
For example, September 2010 represented the second time cotton traded for more than $1 a pound since the Civil War (84 cents in February 2014). The S&P Goldman Sachs Commodity Index declined 33.1% in 2014, declined another 32.9% in 2015, but was up 11.4% in 2016.
Growth of $1 [1926–2016] Growth of $1 [1981–2016]
5-Year Gov’t Bonds
5-Year Gov’t Bonds
20-Year Gov’t Bonds
20-Year Gov’t Bonds
In 1934, the Bureau of Labor Statistics began to gather daily commodity prices. This information eventually became the CRB Spot Market Price Index, price changes for 19 actively traded commodities. The CRB Index is equally weighted; each component has the same weight and importance.
Since 1947, the inflation-adjusted price of the CRB index has steadily fallen, with two exceptions—the 1970s and late 2000s. The inflation-adjusted annual decline of the CRB Index has been ~ 1% per year over 69 years, a cumulative, inflation-adjusted loss of ~ 50%. For the 5-year period March 2012 through February 2017, CRB had a 40% cumulative loss. Although these numbers are quite surprising, they are logical once things like new technologies, recovery systems, increased foreign competition, price controls, tariffs, and substitutes paid for by governments are factored in.
The notion certain commodity prices are destined for permanently higher prices (“they’re not making any more oil…or land”) is likely to be proven false. After all, newspapers have carried stories about oil shortages since the early 1900s. The first large oil field in Pennsylvania resulted in oil selling for $20 a barrel, well over a hundred years ago. A year later, the price dropped 99.5% to 10¢ a barrel due to new discoveries.
Typically, energy dominates commodity markets and generally represents ~ 80% of the value of all commodities traded (since currencies are not considered a traditional commodity and not included in most indexes). This means capitalization-weighted indexes are heavily influenced by energy prices.
According to The Wall Street Journal March 2011 article (oil was $100 a barrel), “Adjusted for inflation, the price of oil has tended to go down, not up.” During the Civil War, a barrel of oil cost $168 in 2011 dollars. At $100 a barrel and adjusted for inflation, oil was just 4% higher in March 2011 than it was at its January 1981 peak. Over the past 30 years, the average annual gain for oil, adjusted for inflation, was 0.014%, an annual return much lower than money market funds.
The S&P GSCI Total Return Index reflects returns from 24 physical commodity unleveraged contracts plus the T-bill rate of interest earned on funds committed to the trading of the underlying contracts; the index is weighted as follows (February 2017): 60% energy, 18% agriculture, 10% industrial materials, 7% livestock, and 4% precious metals.
The index does not reflect any expenses or costs. The S&P North American Natural Resources Sector Index (63% oil & gas, 18% energy equipment, and 15% in metals and materials) generally corresponds to the returns from ~ 150 U.S.-traded natural resource-related stocks (see next page).
S&P Commodity Index ETF vs. Natural Resources Funds
S&P GSCI Index
Natural Res. Funds