Investors looking for protection against wild stock market swings in the second half of 2019 may want to consider devoting a portion of their portfolio to commodity ETFs. Not only do commodities add diversification benefits in good times, but they can also act as safe havens in market downturns, an important feature as the foundations of the current decade-long bull market begin to appear increasingly shaky. But rather than playing the commodities futures markets directly, or buying physical bullion, investors can keep things simple and opt for a commodity ETF, according to Barron’s.
Some commodity-ETF possibilities include the Invesco DB Commodity Index Tracking Fund (DBC), the iShares S&P GSCI Commodity Indexed Trust (GSG), the iPath Bloomberg Commodity Index Total Return ETN (DJP), the Invesco Optimum Yield Diversified Commodity Strategy No K-1 Portfolio (PDBC), and the United States Commodity Index Fund (USCI).
What it Means for Investors
One of the most fundamental principles of a good investment strategy is diversification. While many investors may follow that principle by investing across the spectrum of stock sectors and dedicating a section of their portfolio to a variety of bonds, sometimes commodities can be overlooked. But as an asset that exhibits low correlation with both stocks and bonds, commodities can help investors maintain overall returns while lowering their overall risk.
“Commodities are used for diversification, as they have low correlation to stocks and bonds,” says John Love, CEO of ETF firm USCF Investments, and who suggests that a good starting point for most investors is a commodity exposure of somewhere between 5% and 15% of the value of their portfolio. The benefits to diversification don’t increase much beyond those exposure levels.
Commodity ETFs provide investors a simple way to get exposure to the underlying price movements of commodities. Unlike buying physical bullion, investors don’t have to worry about storage costs or insurance, and unlike buying commodity futures, investors don’t have worry about things like negative roll yield when rolling over a futures contact during a period when the market is in contango. Commodity ETFs trade more like stocks, something most investors tend to be more familiar with.
“[Most investors] only want exposure to price changes. They are more comfortable with ETFs,” says Jeffrey Christian, managing director of commodity consulting firm CPM Group in New York, according to Barron’s.
While commodity ETFs may have similar returns and volatilities to stocks over the longer term, the fact that the two asset classes have little correlation means that the diversification benefits of maintaining returns at lower levels of overall risk are still there. Commodity ETFs also act as a hedge against inflation. While fees can be higher than typical stock ETFs, investors can limit costs by investing in funds with large trading volume as the greater liquidity compresses bid-ask spreads.
The iShares S&P GSCI ETF comes with an annual expense of 0.75% and an average daily trading volume of 652,000. The ETF has a 63% exposure to energy commodities, such as crude oil and gasoline, with the remainder of its holdings in agricultural products, livestock, precious metals, and industrial metals. The Invesco DB ETF has an annual expense of 0.85% and an average daily trading volume of 2.1 million. The fund has just a 44% exposure to energy, making it a better option if investors already have exposure to the energy sector through energy stocks.
Despite stocks hitting new highs, the strength of the bull market is looking increasingly tenuous as forecasts of slowing global growth mount and global trade conflicts persist. If investors don’t have exposure to commodities, they may want to consider doing so. Commodity ETFs offer a relatively simple way of gaining that exposure.