Commodities – They Have (Almost) No Place in Your Portfolio

One of the things I really hate about the current Wall Street environment is how so many people have been fooled into thinking that commodities are a necessary part of your asset allocation.  I’ve been pretty hard on commodities over the years (see this detailed piece here).  I think it’s mostly just a ruse to sell another group of products and I think it’s really dangerous.  But even worse, I just think betting on commodities is fundamentally flawed thinking.  Not only are you speculating in a zero sum game involving production-less input costs, but you’re directly betting against human ingenuity.  I don’t like either of those bets.

If one actually takes a look at the long-term real returns of commodities you realize they’re actually quite dreadful.  Even if we cherry pick a decent period that includes a big boom like the last 20 years we still see pretty awful performance.  Over the last 20 years commodities have returned just 1.6% per year over the last 20 years  (see figure 1).  That’s a real return of about MINUS 1%.

I prefer to think of commodities as something that are an input or a means to helping us innovate.  If you’re bullish on oil price dynamics you shouldn’t go buy barrels of oil and store them in a locker somewhere.  You should find the companies who leverage the use of that commodity and will benefit by innovating through the use of that input.  Don’t bet against innovation.  Bet on it.

I say all of this as I see the silver bubble (that I discussed back in 2011 when silver was 40% higher) come crashing down.   Sensible portfolio construction starts with understanding the role of specific assets in the economy and how those various assets fit into your portfolio in particular ways.  I don’t know why this theme of commodities as an asset class has taken off over the last 10 years, but it sure doesn’t seem to be helping anybody except those selling the idea….

Chart via Orcam Financial Group:



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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • LVG

    Just the latest Wall St fad thanks for David Swensen. Now the shine seems to be coming off that approach.

  • ryan

    Very informative article Cullen. Thanks. What are your thoughts on silver ? It has utility plus the precious metals aspect.

    An interesting technical analysis can be found here :


  • ryan

    and what % would you recommend for commodities ? I dont like the idea of betting against innovation either but I do believe there is a certain weight that should be included. Curious what you think it is.


  • Alberto

    Decent but incomplete reasoning. Some commodities are usefull sometimes as an inflation hedge, but now we’re already into a renewed deflationary leg as almost all indicators are pointing to. There is abolutely nothing the CB can do about it, only fiscal policy can beat deflation and in that case CB has just to provide ammunitions. Furthermore there are cases when you can bet safely on commodities, for example if oil falls below the full production cost of the last decile of the production spectrum that is about 80 – 90 $ (brent). The recent case of the gold crashing is just the n-th red light on the coming deflationary shock. Copper is going down, oil is going down… so or the economy has to be rewritten or earnings will disappoint a lot in the near future.

  • Martin T

    Totally agree with you Alberto, the great Boogeyman is deflation right now, and you are correct, metal prices (and Dr Copper), oil, gold, silver, are all telling us the same story.



  • Alberto

    Martin, there is always a disconnetion between reality and perception. One of this disconnection is about the EM economies (expecially China) that is going BAD to WORST at least if we look at it with the eyes of a long only stocks investor. China must rebalance or will perish but a rebalancing will be very deflationary. Local autorithies are start to fight the final battle in order to reduce the influence of the vested interests behind the export driven model. If before the end of summer we will see a revision of the China GDP much lower this is very good for China for a long term perpspetive and very very bad for the western stock markets because the circulation of capitals will be impaired. China’s export vs the US are at the lowest point in the decade as % of GDP and the opionion of some pundits that the internal chinese market is open for foreigners is complete nonsense. It’s very difficult to understand an extremely complex and unstable environment as this one, but if the main engine of growth will change everything else will change.

  • DH

    Dude, perhaps a dozen years ago (I have no idea of the actual date), some bright Wall Street executive used financial innovation to turn commodities into an asset class.Prior to this, commodities has sellers (who wanted the highest price), buyers (who wanted the lowest price), and speculators (who just wanted volatility). They traded contracts and risked delivery if they weren’t careful.

    Then came commodities as an asset class. ETFs are the trading vehicle and they operate like stocks. You buy a share in a commodity ETF and you wait for the price to rise. Commodity ETF money may even be represented by actual commodity contracts that the ETF buys to secure the ETF fund (See Goldman Roll) . Thus, ETF commodity buyers have the same interest as contract commodity sellers who both want high and rising prices. Buyers and sellers are on the same side of the trade.

    Commodities have NO place in a portfolio because all they do as an asset class is cause prices of everything the commodity is used for to rise when gullible ETF buyers think rising commodity prices reflect a growing economy. Commodities as asset classes are actually choking the economy. ETF buyers alone usually cause the commodity price rise.

  • Andre h

    You (as always) make a good point here on commodities. But to not participate with them in the portfolio is a mistake. A prominent fund manager I worked for a long time ago advised me its the “expression” of your investment that makes the difference.

    Back to commodities, some investments that I have participated in that have generally worked are upstream MLPs for example. (LINN energy, EVEP etc). I am bullish crude long term and also use them as somewhat of a hedge against the fixed income portions of my portfolio. These are tax efficient, have equity characteristics, and yield 5 pct or above – my expression of the theme.

    If I bought a crude only ETF maybe I would have been spanked by now. But my expression is holding up.

    My 2 cents.

    You also make an excellent point – it’s got to be part of a thoughtfully constructed portfolio. Fr example I have a bunch of (private equity) Nat gas drilling exposure. So as a hedge I own some nitrogen fertilizer MLPs. They behave inversely with Nat gas prices (and yield similarly to aforementioned MLPs), because nat gas is their main input cost in production. Any case they have gotten crushed by (inexplicable?) recent rise in Nat Gas but have offset other areas in the portfolio- creating a hedge.

    Conversely ETNs and so forth are roller coasters. Using futures these pure play commodities don’t capture the “innovation” you cite in companies, don’t yield and aren’t terribly tax efficient. They are good short term trading vehicles but they can be riskier in many ways.

    My point: I think ruling out commodities for the most part is a mistake. Do your homework in big themes, find solid companies, good ownership structures and participate – its the “expression” and “construction” that matters.

  • Andre h

    Sadly, I have to comment on my comment! Timing and discipline also matter.. You simply can’t jump in at the top. This is especially true of commodities and commodity exposed companies.

  • Andrew P

    It’s not just ETFs. Increasing demand over the last 10 years can be attributed to an unusually high demand for commodities from China, and ETFs emerged as a way to play it. When a single country is consuming more than half of the entire world’s output of cement and steel, it has to have an effect across the board on metals, materials, and fuel. Now the China super-growth story may be nearing an end. A rebalancing could be taking place.

  • Alberto

    yeah, american pension funds which should deliver 7% appreciation y/y are full of this crap. Thank you banksters, you’ve fucked a couple of generations.

  • Wantingtoretire

    And as they say past performance is no guide to future performance……

  • Andrea Malagoli

    I have spent a fair amount of time working with commodities. I would agree that they do not belong to a portfolio in a traditional sense (certainly not through indices).

    When investing in commodities, the investment vehicle (future, MLPs, commodity-related equities, … ) makes a big difference.

    There is not such thing as “investing in commodities” per se.


    Cullen, one reason that people have added commodities as part of their asset allocations is because “human ingenuity” created a highly leveraged, unstable financial system. Commodities are an investment outside of this system.


    If we are indeed facing deflation once again as some writers above have argued, and QE has distorted virtually all asset prices, won´t all asset prices, except for cash, face severe price corrections going forward? It seems commodities are just the first domino to fall in an across the board asset wide market correction of both “productive” and “non productive” assets. Any thoughts? I think we´ve all seen this film before…

  • http://pragcap Michael Schofield

    IMO if you must get into commods, make sure losses are limited to 1% of account, or even net worth per position. Remember this is a TRADE. Risk/reward is the key. Today’s move (or even Friday’s) in gold and silver should show why.

  • DH

    Yes, 7billion consumers worldwide have a significant effect on price. My belief is that etf’s corrupt the pricing mechanism and put both buyers and sellers on the same side of the trade. Prices for commodities are higher than they otherwise would be and etf’s are a drag on the entire economy. They fill no social good.

  • Tonka

    Cullen, if commodities are just inputs for other companies to leverage human ingenuity, by this logic do commodity producers also have very little room in a persons portfolio?

    I personally tend to feel that way, but mostly because mining corporations are some of the most poorly run companies out there.

  • jt26

    Great timing Cullen … perfect headline for today!
    Does anyone else have that eery feeling from July 08?

  • Alberto

    But sometimes because of margin call liquidation the cost of a commodity can go lower than the production cost. The case of US nat gas is another example of financialitazion at his worst: initially is benign, having such a low price is good but later on is dramatic. Investments will stop, corps go bankrupt and what follows is many years of lower invstments than necessary to keep on pair with a growing economy. Finance ha already destroyed this world but it is normal when you read something like this:

    “… But really, how fragile is the economic picture? Here’s one indication: Atty. General Eric Holder (for Pres. Obama) recently stated that he would not criminally pursue the mega-thieves at Bank of America, HSBC and other too-big-to-jail banks because it would just be too “unsettling” for the economy. The Attorney General is afraid to prosecute the most dangerous financial criminals in American history. In essence, the U.S. Government has not just offered the banks the courtesy of underwriting their moral hazard, it’s eliminated the obstacle of law for them as well. At this point, Federal policy reeks of desperation. That’s how fragile the economy is…”

  • Kafkaesque

    Surprised to hear you say this, Cullen. I’ve got about 3% of my portfolio in GLD because its correlation with other asset classes is low, not because I have a thesis on its “correct” price. Sure, today sucks, but I’ve held it since 2005 and am not rethinking it because of the last 2 days.

  • SS

    I’ve seen Cullen say he’s not opposed to a 5% gold weighting as an exception to his commodity hatred.

  • Aaron

    Long-only commodities is bad. A long/short commodity CTA is different. They are trend followers and go short as easily as they go long. Supply/demand imbalances can go on for years in some commodities. I think it’s prudent to add CTAs to a stock/bond portfolio. In 2008 which funds with long-term track records did the best? CTAs.

    Commodities are a zero sum game, and the research shows that commodity speculators profit at the expense of the commodity hedgers. The hedgers are willing to lose at the hedging game, because to them it’s just an insurance policy. Airlines would gladly take a loss on their fuel hedges, because that means that their main business will benefit even greater. Who gets the $$ from their losses? Speculators. Specifically – trend following CTAs.

    It’s fairly easy for the layman to recreate a trend following portfolio these days using ETFs. Sure, creating the system is going to take some work and study, but it can be done. For the wealthy person or institution, it’s even easier.

    An no, I don’t have any interest in CTAs. But I do have my own ETF trend following system. And I don’t expect it to return 1% a year either. It complements my equity system. When one is down, generally the other is up.

  • Stephen

    Long cycle stuff not a whole lot different to property. Your average punter has all the hedge he needs wrapped up in his personal house without messing around in a commodity market he has little real knowledge of. Very similar stuff. When you can’t get away from the media noise exciting you to flip a house you know it’s run it’s course for a long time. When every other new fund launch is telling ypu how necessary it is to own comms in your portfolio you know it’s time to look for an orderly exit.That by the way was back in 2011 latest. Both are not going to function on a recency basis IF the main ingredients are no longer present.

  • Ryan Melvey

    You can’t look at commodities returns in isolation to determine if they merit a place in your portfolio. The combination of low correlation and high volatility means that commodities can offer a strong diversification return if you methodically stick to your rebalancing bands.

  • Tom

    Dont know if you saw or care….but randomly checked out marketwatch and read this article. You got a shout out in this article Cullen.

  • Tim

    Your citation about the 20 year return of commodities (1.6% per year) is a bit misleading…first of all, the mass of investors did not buy and hold commodities from that start date, so the 1.6%/year experience is not wide ranging. Secondly, if you include 5 OR 10% commodity allocation in a simple 60/40 portfolio, it does improve the average and median sharpe ratio over rolling five-year periods. So from a risk-adjusted standpoint, utilizing rolling periods which are more likely to capture investor experience, a commodity allocation has been beneficial. Are the benefits HUGE? No, but they are there.

  • AFG

    You are missing something that most people that right about commodities seem to miss. Investing in commodity FUTURES is not the same thing as investing in commodities.

    When you buy commodity future, which is how nearly ever fund invests in commodities, you are getting a premium for accepting the price volatility associated with the underlying asset. You become an insurance seller for companies that need to hedge their input price risk.

    Read this article and you will see the long term returns are pretty good:

  • bart

    “Commodities – They Have (Almost) No Place in Your Portfolio”

    The underlying assumption is that applies in a bull market, which is of course correct.

    But, just like between 2000 and 2003 the wise move was to short stock indexes, shorting commodities has been profitable for years, as was a short gold today… and in spades.

    In other words, eliminating half the market from investing or trading is odd, and can easily be viewed as unwise.

  • andre h

    No one is an oracle.. bur grantham’s L-T performance is strong…. check out his views on some commodities for next few decades….. I think its compelling LT supply demand… again the timing (buy low ie today!), plus the expression (ie be careful of futures ETF etc, consider companies etc)..

  • jaymaster

    But Andre, you are NOT investing directly in commodities!

    You are investing in companies that process and handle commodities.

    There’s a difference, and it’s one which I think Cullen touched upon here. You are putting your faith in the management of these firms, and their abilities to plan and react to various movements in the price of and demand for commodities.

    And that’s an approach I support whole heartedly, btw.

  • InvestorX

    Just saw some BCA charts – the credit impulse (second derivative of non-financial credit) has globally turned negative again (after epsiodes like May 2012, May 2011, February 2009 etc.) – amazingly how frequent the swings are – “risk assets” have followed the pattern, together with the recession calls, but it seems every time QE (or else?) has rejuvenated animal spirits to go on a new borrowing binge. How sustainable is this – no idea. The recent drop is less severe than the previous two though.

  • Mr. Market

    It depends on WHEN one invests in commodities. Currently it’s a dismal time to think going long commodities. Currently I am short a number of commodities.

  • Lundy Hill

    I laugh when I see this. You don’t buy and hold commodities. My Great, Great, Great Grandfather left me a bushel of wheat from 130 years ago. guess what – it went bad. You trade commodities. They are COMMODITIES. When price gets high, more supply comes to market to drive prices down. When prices are down, suppliers leave the market to drive prices up. It’s not Apple company releasing constantly new and improved products and gaining market share. Its a commodity. Buy value. Short over supply. you TRADE commodities.