Commodity ETF Bets Are Not For The Long Term

Commodity ETF investing is not the same as investing in ETFs tracking broad stock indexes. For example, ETFs tracking major indexes like S&P 500 or Dow Jones have come up with strong performance in the long term. Commodity investing on the other hand has not generated impressive returns in the long term, as commodities are more volatile than stocks.

SPDR S&P 500 ETF (NYSE:SPY) (AX:SPY) and SPDR Dow Jones Industrial Average (SI:SPDR) ETF (V:DIA) have returned 78.8% and 79.7% in the last five years, respectively against a loss of 36.9% in the last five years for PowerShares DB Commodity Index Tracking Fund (HN:DBC) .

Why Does Commodity Investing Lose Appeal in the Long-Term?

The primary factor reducing the appeal of long-term investing for commodities is its cyclicality. Commodities are hugely cyclical and boom and bust cycles in the overall markets greatly affect its performance. For instance, crude prices surged to a record of $147 in 2008 before hitting $26 in February 2016. However, it again surpassed $60 levels in 2017 owing to OPEC and Russia’s production cuts.

This shows that when prices are rising, producers increase output, resulting in a demand-supply gap, which eventually weigh on prices. This is followed by a cut in production to support prices, increasing the volatility for commodity performance.

Apart from cyclicality, commodity investing also suffers from storage costs and issues relating to primary stakeholders, given that participants in the commodities market not only include investors but also buyers and producers. Coming to storage costs, they are unavoidable because despite the performance of the commodity, storage costs have to be incurred.

Moving on to how stakeholders impact commodity prices compared to stock index investing, commodity markets are also greatly influenced by the primary stakeholders, buyers and producers. For instance, a good production season might lead farmers to have excess inventories and as a result, reduces crop prices.

Coming to the impact of technology on stocks and commodities, per a Wall Street Journal article, analysts believe that improvements in technology improves the performance of stock indices, but weighs on the performance of commodity indices. This is because with advanced technology, production gets a boost and a demand supply gap weighs on prices.

As a result, these products are not appropriate for long-term buy and hold strategies. Investors interested in entering the commodity space should look at it as short-term investments. Moreover, owing to the high risk profile of these investments, active investors who can rebalance their portfolios in short periods of time should look at these investments.

Let us now discuss a few ETFs focused on providing exposure to the commodity space.

PowerShares DB Commodity Index Tracking Fund (DBC)

This ETF seeks to provide exposure to the broad based commodity markets through futures contracts. This fund has the potential to offer diversification benefits to traditional portfolios.

It has AUM of $2.6 billion and charges a fee of 89 basis points a year. The fund has high exposure to WTI Crude, Brent Crude and NY Harbor ULSD, with 13.5%, 12.7% and 12.6% exposure, respectively (as of Feb 23, 2018). It has returned 1.6% year to date and 8.2% in a year.

iShares S&P GSCI Commodity-Indexed Trust GSG

This ETF seeks to provide exposure to the broad based commodity markets through futures contracts. However, it is heavily skewed toward energy.

It has AUM of $1.5 billion and charges a fee of 75 basis points a year. The fund has high exposure to Energy, Agriculture and Industrial Metals, with 61.9%, 15.7% and 11.2% exposure, respectively (as of Feb 23, 2018). It has returned 2.1% year to date and 8.2% in a year.

iPath Dow Jones-UBS Commodity ETN DJP

This ETF seeks to provide exposure to the broad based commodity markets through futures contracts. This fund has the potential to offer diversification benefits to traditional portfolios.

It has AUM of $1.1 billion and charges a fee of 70 basis points a year. The fund has high exposure to Energy, Grains Oilseeds and Industrial Metals, with 30.4%, 21.4% and 20.9% exposure, respectively (as of Dec 29, 2017). It has returned 0.9% year to date and 3.2% in a year.

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