Those who loaded up on gold, oil and other commodities a few
years ago in anticipation of raging inflation related to
quantitative easing are likely very disappointed.
As most investors probably know, commodities have trailed
stocks pitifully in recent years. The Dow Jones-UBS Commodity
Index (DJ-UBSCI), which tracks a group of 20 commodities, fell
6.5% a year for the past three years, while the S&P 500
gained 17.6% annually during the same period.
But one of the nice things about investing is just about
everyone gets a chance to be right if they wait long enough...
and commodities investors may finally be having their day.
Indeed, commodities appear to be staging a comeback, with the
DJ-UBSCI already up more than 7% this year, compared with a 5.6%
gain for the S&P.
One probable factor in this resurgence: rising consumer
prices. According to the latest inflation data (released by the
Bureau of Labor Statistics on June 17), the Consumer Price Index
) jumped 0.4% in May -- twice the 0.2% increase economists
expected. What's more, May's 0.3% increase in the core CPI, which
excludes food and energy, was the largest since August 2011.
With inflation apparently accelerating, investor demand for
commodities will probably also continue to rise, since
commodities are widely considered to be excellent hedges against
inflation. They also tend to have weak correlations with stocks
and bonds, meaning if the latter are dropping in price then
commodities will probably be gaining value.
However, it's easy to get burned in commodities because of
extreme short-term price swings, which end up spooking many
investors into selling at large losses. That's why it's a good
idea to make commodities a relatively small part (no more than
about 10%) of your overall portfolio. It's also best to own a
broad basket of them for maximum diversification and lower
The best broad-basket commodities investment I've seen is
PowerShares DB Commodity Index (NYSE:
, an exchange-traded fund (
) that provides exposure to the world's most heavily traded
commodities such as oil, gas, gold and other metals, and
agricultural products like corn and wheat.
The fund has been around since 2006, so it's well-established.
It's also popular with investors, with invested assets of $5.6
billion and a reasonable 0.85% expense ratio.
Like any index fund, DBC has to mirror a benchmark -- in this
case, the DBIQ Optimum Yield Diversified Commodity Index, which
typically holds 14 different commodities futures (contracts to
buy or sell assets at predetermined future dates and prices).
DBC's holdings as of March 31:
Of course, DBC never actually takes possession of the physical
commodities underlying its futures positions, as this would be
impractical. Rather, like its benchmark, the fund follows a
so-called optimum yield strategy.
With this method, futures that are about to expire are sold
and replaced with equivalent contracts set to expire at later
dates in a process known as rolling. The goal of rolling is to
get the highest possible roll yield -- the amount of return
generated when swapping out one futures contract for another,
based on the contract prices.
Over time, rolling futures with an eye toward optimum yield
helps to minimize the negative effect of
, a term for when expiring contracts are trading at lower prices
than the ones that will be replacing them. In that case, the fund
has to shell out more for the replacement than it got for the
expiring contract. Conversely, the optimum yield strategy helps
to maximize "
," which occurs when expiring contracts are trading at higher
prices than their replacements.
While an optimum yield approach can significantly affect fund
returns, the main factor in DBC's long-term performance is the
value of the commodities underlying its futures holdings -- and
as I said, commodities look set to go up.
DBC's current record reflects recent travails, though. During
the past three years, the fund lost about 3% a year. Still, it
soundly beat the DJ-UBS index, which declined more than 6%
annually during the same period. DBC's trailing three-year record
places it in the top 45% of its category.
Risks to Consider:
Because it's a broad basket, DBC is certainly less risky than
individual commodities futures. However, investors should still
expect some pretty big price swings from the fund, which has been
23% more volatile than the S&P 500 during the past three
Action to Take -->
Investors seeking to hedge against inflation with commodities
should consider DBC because of its diversification, solid
performance, greater safety and low cost.
The only unusual thing about the fund is that it's classified
as a partnership for federal income tax purposes. This means
investors must account for their proportional share of any
income, capital gains or losses, or deductions passed through to
them by the fund. This is typically done on Form K-1 at tax
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