We often see portfolios that also hold investments in commodity ETFs or funds. Read more to find out whether such investments make sense.
What are commodities?
Before we can decide whether investing in commodities is worthwhile, we must first distinguish between the 4 different types of raw materials:
Precious metals such as gold and silver are popular with investors because they have a long history as a safe investment . In times of economic uncertainty or high inflation, precious metals can serve as a hedge against currency risk and capital losses.
Industrial metals such as copper (Dr. Copper), aluminum and zinc are highly dependent on the global economy, are subject to long cycles and have a correspondingly high risk of volatility.
Energy commodities such as oil and gas are important raw materials for industry and transportation. Investments in energy commodities may depend on global energy demand and are therefore subject to high volatility risk.
Agricultural commodities such as corn, wheat or soybeans can be interesting for investors because they tend to have a lower correlation with stocks and bonds. However, the prices of agricultural commodities can fluctuate widely as they are influenced by various factors such as crop yield, weather conditions and global demand.
What are the properties of raw materials?
Commodities offer protection against inflation and would actually be an interesting asset class.
However, storage costs are high for most raw materials and agricultural products even spoil. Therefore, most raw materials cannot be invested in directly, but only indirectly via so-called futures contracts .
In concrete terms, this means that oil, for example , is not bought today (on the 'spot market'), but at a point in the future ('forward contract').
Due to storage costs and expected inflation, prices are usually higher in the future. Financial experts call this “contango”.
Using wheat as an example, it would usually look like this:
Here you can see that the price (vertical axis) of wheat in the future (in x months on the horizontal axis) is higher than today (time 0).
Once the futures contract expires, the contract is closed and the fund must enter into a new futures contract, often at a higher cost. For this reason alone, an investor in such futures contracts generally loses money over time (we also call this effect 'rolling down the (futures) curve'.).
And how have commodity funds developed in the past?
As an example, we can look at the popular “UBS ETF (IE) CMCI Composite SF UCITS ETF (USD) A- acc”: over the last 10 years, this fund has returned around 10% in USD, or less than 1% per year.
With the asset class hedged in Swiss francs (CHF) you would have even lost money:
This commodity fund invests broadly across all asset classes in the commodity sector with the following weightings: Energy: 32.1%, Agriculture 30.8%, Precious Metals and Stones 6.5% and Livestock 4.6%. You can see the exact (current) composition here:
If the fund had not invested in gold, the return would have been even worse, but more on that later.
The same picture emerges with ETFs that invest in commodities. As an example, we can look at the Amundi Bloomberg Equal-weight Commodity ex-Agriculture UCITS ETF Acc in Euro:
So the problem exists regardless of whether you invest in a fund or an ETF:
What does this mean for you?
'Traditional' commodity funds are very popular with investors because they help diversify the portfolio. However, the expected return is usually very low and in many cases even negative. A long-term investment in such products therefore usually makes no sense. There are also commodity funds that optimize investments in futures contracts and some of them have historically performed better. However, you have to analyze this carefully so that you understand the risks and opportunities.
Is this also the case with precious metals?
However, there is an important exception when it comes to raw materials : for precious metals such as gold and silver, storage costs are very low and precious metals do not spoil. This means that an ETF or fund can invest directly in precious metals without having to use futures contracts.
You can find out how gold and silver fit into your portfolio and what you need to pay attention to in our blog post on this topic.
Happy investing!
Jeff Haindl & Reto Rauschenberger
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