The short answer to the question above is, probably not. Using an indexed based approach to commodity investing is futile. If you’re investing in commodities, it’s best done using an active approach. Simon Constable explains why in The Wall Street Journal writing:
1. Unlike for stocks, the influence of technology on commodities is deflationary.
Consider the massive profits generated by tech companies like Facebook Inc. and Alphabet Inc. New technology has helped power big gains in those stocks. And technology has helped fuel gains in stocks outside the tech sector, as well, by improving the productivity of many companies. But technology generally has had the opposite effect on commodities.
“In the long run, there is a downward bias in prices because of technology,” says Mayer Cherem, sector specialist for opportunistic investments at Pacific Alternative Asset Management Co., or Paamco, in Irvine, Calif. That’s because new, improved ways of extracting oil and minerals or growing crops boost production, putting downward pressure on prices.
Mr. Cherem points to the rapid development of shale-oil production in the U.S. in recent years, thanks to new technologies, which has helped increase the supply of natural gas and oil and depressed their prices.
Likewise, he cites growth in the production of foodstuffs such as wheat and corn, for which per-acre yields have shot up over the years.
2. The ultimate users of commodities aren’t the same as the buyers of stocks.
Stock prices are driven entirely by investors. The same isn’t so for commodity prices.
In the commodity markets, the participants include not only investors but also the producers and buyers of the commodities, and the actions of all of them affect prices. Farmers, for instance, must sell their crops. This can mean that after bumper crops, inventories can rise to levels that flatten prices for extended periods.
Worse still, because commodity markets typically have many sellers that can’t individually influence the price, there is sometimes a tendency for all to want to maximize production, which pushes prices lower.
3. Commodities are inherently cyclical.
Most commodities roll through regular boom-and-bust cycles.
For instance, in 1998 crude-oil prices dropped to a low around $11 a barrel. Then they soared to a record $147 a barrel in 2008. They hit $26 in February last year. The reason for this cyclicality in commodities is that when the prices for materials and foodstuffs are high the producers step up output.
Eventually the higher production swamps demand and pushes prices lower. When prices get low enough, producers cut back. That allows demand to catch up to production, and prices start climbing again.
Read more reasons by clicking here.
Jeremy Jones, CFA
Latest posts by Jeremy Jones, CFA (see all)
- American Stocks Can’t Outrun the World Forever - April 25, 2019
- Just Four Stocks Have Generated Half of the NASDAQ 100’s Gains in April - April 24, 2019
- Will Every Recession Now Demand Extraordinary Fed Intervention? - April 23, 2019