Gold Hits $1000 but Long-Term Perspective for Commodities Doubtful
Sep. 08, 2009
Today the gold price has surpassed the “magic line” of USD 1000 per ounce. Other commodities like oil or certain metals have also come back a long way from their lows at the end of 2008. It seems that with some silver lining on the horizon of the economy, commodity investors have become especially bullish again.
So we think it is time to revisit some basics and long-term data on commodities. For the investor, as opposed to the speculator, it is important to have a thorough look on the long-term trends of the commodity markets in order to understand possible future trends.
Let’s start with a basic question: What are commodities? These are typically basic resources and agricultural products such as gold, silver, iron ore, oil, coal, coffee, soybeans, rice or wheat. As you can already make out from this incomplete list, the term commodities describes very different products or assets. Some commodities, gold in particular, has a reputation for being a safe bet in times of economic crisis or inflation.
Naturally everybody is most interested in this question: How do commodities perform? There is considerable debate on the real performance of commodities. Commodities as an asset class are very heterogeneous, so the return on a certain commodity index or basket of commodities can vary quite significantly. One big issue is that an investor is not able to invest directly in most physical commodities like oil or soybeans because he lacks the storage capabilities. For most commodities it only makes sense to invest in future contracts traded on various exchanges. A future contract obliges one market participant to sell or buy a certain amount of a commodity at a specified date in the future. Research essentially shows that the inflation-adjusted return on a broad basket of commodities futures has been close to zero over the long-term . If you look specifically at gold, the zero return in the long term has also been well established. This, despite the fact that the gold price has had wild ups and steep downs over the last 200 years. Consider that today, almost 30 years after the all-time record high of price of $850 in January 1980, the nominal broke the record. But in inflation adjusted US dollars, the price would have to reach about US$ 2,200 to break the record in real terms. However, it may be possible that specific commodities, specific portfolios of commodities or certain commodity indexes can have a positive return in the long-term.
Not to forget: What about the risks associated with commodities? It is widely assumed that commodities correlate inversely (negatively) or not at all with the price of stocks or bonds. For this reason some investors assume that commodities could decrease the risk of a portfolio significantly through diversification. In fact, the negative correlation has been true only during certain periods (like the high-inflation period in the 1970s and the beginning of the 1980s). At other times commodity prices have crashed while stocks came down as well (like in the recent past).
In summary, for the long-term investor commodity investing offers only very limited advantages. The commodity investor needs a substantial level of knowledge about the markets and the fundamental forces that drive them up and down in order to pick the “right” basket of commodities. As a hedge and portfolio diversification commodities can play a role but diversification through commodities works only under certain scenarios like, for instance, in periods of higher inflation. Whether the gold price will increase further is not predictable. Over the long-term gold has never been a good investment. Yet, if you think it likely (as many economists do) that a scenario of high inflation will realize over the next few years, it would make sense to hold a share of around 5% to 15% of your assets in commodities.