Portfolio Design: A Modern Approach to Asset Allocation

Chapter 12

Real Assets—Commodities

Precious commodities, especially gold and silver, have been cherished by investors through the ages. In wars or revolutions, these assets were portable and could be hidden so they afforded protection against seizure. And even in peacetime, these real assets protected against the corrosive effects of inflation. In this relatively stable historical period, investments in commodities ought to be evaluated in terms of returns and risks rather than any other characteristics. Gold is suitable for earrings and necklaces, but is it suitable as an investment? This chapter will focus on commodities as an asset class.

There are four distinct ways to invest in commodities:

1. Direct ownership of the commodity

2. Investing in the stocks of commodity-producing companies

3. Passive investment in commodity futures

4. Active investment in commodity futures through managed futures funds

Direct ownership of the commodity has sufficient drawbacks that few investors will elect this option. The carrying costs of direct ownership are high since there is no dividend to offset the financing of the position. There are also storage costs, including insurance, that further detract from any potential return.

Investing in the stocks of firms that produce commodities appears to be more promising. The basic drawback is that these stocks do not provide a pure play on the commodity itself. Consider an extreme example: For many years, Barrick Gold of Canada followed a hedging ...