Is Commodity Investing Dying? Part 1

Commodity futures markets were originally designed for producers to hedge their risks against unforeseen complications. But as the years went on, more and more retail investors began piling into this asset class, as they enjoyed the diversification benefits offered by hard assets. Now, many long-term buy and hold investors allocate anywhere from 5-20% of their assets to commodity holdings, but that trend may be hitting a roadblock [for more commodity news and analysis subscribe to our free newsletter].

A Selling Trend

It is no secret that a number of commodities come handcuffed with volatility, but it seems that their unpredictable nature has yielded unfavorable results in recent years. Many investors and institutions have begun piling out of commodities after finding themselves unsatisfied with the inflation protection and diversification these allocations aimed to provide. “The trend is accelerating this year, analysts and investors said, driven by lackluster returns and looming U.S. regulations that could make these investments more complicated and costly,” writes Ianthe Jeanne Dugan.

“Investors have yanked nearly $10 billion from tradable indexes tied to energy, food, metals and other commodities after two years of record outflows. That leaves about $133 billion,” Dugan continues.

For now, the outflows have mostly come from major institutions, but this may soon infect the retail space, as many take cues from the actions of larger organizations. Some pinpoint performance as the culprit; commodity returns have been relatively lackluster the past two years. Others place the blame on an increasing number of speculatory traders who have no stake in the assets they trade. For the time being, speculators “account for more than half of futures contracts in certain commodities, according to the Commodity Futures Trading Commission.”

Troubled Times

The past few years have seen market conditions in relatively new territory. The Fed is pumping an unprecedented amount of money back into the economy, commodities like gold have seen stellar highs, and major indexes have been plagued with a nagging sense of uncertainty. Some argue that the returns of major commodity indexes over the past few years are attributable to these conditions, but there is no denying the numbers [see also The Ten Commandments of Commodity Investing].

The S&P GSCI surrendered over 30% in the trailing five years while inflation rose at least 6%; though there are many who feel that current CPI figures are flawed in their measurements and that actual inflation has been much higher. And while past performance is not indicative of future results, it seems that those who have spent the better part of the last few years getting hammered by their commodity allocations have had enough.

So far, the reaction to these volatile returns seems to be a mixed bag for retail investors. Of the three largest broad commodity ETFs, DBC, DJP and GSG, one had net inflows for 2012 while the other two saw outflows. DBC raked in just under $1 billion in assets while DJP and GSG lost $591 million and $131 million respectively. It seems that 2013 will be an especially important year for the performance of the commodity industry, and retail investors should continue to monitor the actions of major institutions and endowments when it comes to hard asset investments.

Stay tuned tomorrow for Part 2 of this article for a different take on the industry.

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Disclosure: No positions at time of writing.