Commodities - expected return / risk

Hi folks,

I was just wondering if some could help me out with some theoretical background regarding the role of commodities in a diversified portfolio for an individual. Portfolio consists of a broad and global mix of stock that represents most of the portfolio

Additionally, 6% is in commodities via the ETF DB X-TR.DBLCI-OY BAL 1C LU0292106167 that invests in Oil, Metal, Agrar.

The ETF has shown a terrible performance in the last years that shows a consistent negative trend. I know that might very well be due to the general evolvement of commoditiy prices. But in light of the situation, I was wondering how the situation is from a theoretical point of view. Is this just a coincident or do the costs of investing in commodities (storage, negative roll return) give rise to the assumption that on the long term negative returns should be expected from (this way of) investing in commodities

Could someone point me the right direction regarding this, maybe provide some reliable sources regarding this topic?

Thanks!

Commodities are not the same as equities, fixed income or even real estate, in the sense that commodities do not produce earnings, yield or rents. So, they do not have a fundamental positive return, other than inflation. To expect a positive return from buying commodities or gold, you would have to believe that someone in the future will be willing to pay a higher price for these assets. Perhaps the commodities will be scarcer in the future, or perhaps economic growth will increase their demand. However, either way, the investment return is not intrinsic to the physical assets.

I don’t have any sources at hand unfortunately.

Keep in mind that if you are buying an ETF you’re likely buying futures of the commodity you’re trying to invest in.

A lot of commodities trade in a market characterized by contango which means when the asset manager rolls the futures/forward position they’re buying a higher price than what their existing position is worth. Your “roll yield” will be negative which means you’re going to lose money, particularly important given ohai’s comment, this is likely why you’re seeing

Thanks for yor replys! Let me link two articles that I have found regarding this topic and that more or less reflect my understanding

  1. https://seekingalpha.com/article/3713686-modern-portfolio-theory-introduce-allocation-alternatives
  2. http://www.investopedia.com/articles/trading/05/021605.asp

“As shown in the table above, the introduction of commodities improves Sharpe ratio. Using 1.6x leverage, augmented portfolio would have yielded closer to 15% per annum. Once again, we will discuss leveraging portfolios in the future articles.” This would be my general motivation too. But this makes only sense to invest in when you can at least expect some positive return on the asset class in the long run.

The following article takes up on the discussion about contango we just had

  1. http://www.investopedia.com/stock-analysis/2013/got-a-commodity-etf-watch-out-for-contango-ung-blnd-gld0214.aspx

“Two of the most popular commodity futures based ETFS: the United States Natural Gas Fund and the United States Crude Oil Fund have consistently been losers for investors based on the issues of contango. While the funds are fine for daily trading, holding them long term has spelled disaster. UNG has actually returned a whopping -95% since its inception.”

Seeking Alpha recommends the PowerShares DB Commodity Index Tracking ETF (DBC) that shows a very similar performance compared to the aforementioned DB X-TR.DBLCI-OY BAL.

So again, I am wondering if this is just a longer phase of negative returns or if this will be a normal status for the future time.

@Galli I see the same situation with negative roll returns (as written in my first post) but I am lacking the data to check which commodities are in contango and what the impact of the roll return is. Will it be something in the range of ~-0,5% or more like -2%?

^ I don’t know the monthly loss and have not come across a study focusing on it. If you have access to futures you should be able to see futures curves by product.

A quick search on google came up with this, keep in mind this is an old article.

https://www.rcmalternatives.com/2014/03/7-commodities-in-contango-and-backwardation/

To follow up on this:

I found a lot of articles about the negative effects of contango, it is like a rabbit hole. One that is very interesting I want to share here is about a direct comparison of a oil and a gas ETF to the evolvement of spot price. This looks rather devestation.

https://etfdailynews.com/2010/07/22/why-long-term-investors-lose-money-in-commodity-etfs-uso-ung/

Sadly, I could not find more information about which etf holds how much of commodities that are in contango, what the roll effect has been about the last year etc. Questions that surely rise to any investor thinking about this.

So, for me I have come to the conclusion that this investment is rather dubious and the hoped for longterm diversification is not worth the risk / lack of understanding. Thus I have closed out the position for now.

I still would very much like to know more about this investment, so any comments are much appreciated.

I’m not keen on commodities myself. High vol, low expected return in the long-run. They do tend to have low correlations to other asset classes, but I don’t think that’s enough to make them worthwhile.

Stick to equities, fixed income, real estate and infrastructure in my opinion. If liquidity is not a concern, then invest in illiquid assets for the long-run premium pick-up.

Don’t over complicate it. There is only 1 negative effect of contango on ETFs, it’s losses.

Stay away from etfs.

What do you mean?

Stay away from commodity ETFs, especially if they are an L.P., which I think a lot of them are. Really crappy to buy an oil ETF when wti spot is around $35/bbl, sell when wti spot is around $50/bbl, take a 1% loss, AND get a K1 to deal with. Screw those vehicles.

You could just buy a bunch of precious metals and store them in your home.

Well, this is not a convinient option. To be honest, I am quite confused that there seems to be no easy and inexpensive way to get a exposure on commodities. For gold alone this is no problem. There must be some way to get exposure to a broader mix or basket of commodities??