Investing versus Gambling | The Problem with Commodities
Gambling is speculation. One cannot assume any expectations based on the amount of risk one takes. You could win $50 million from a $5 lottery ticket or you could bet $50,000 and win nothing. Investing is quite different. Investing in capital markets has a positive expected return for risk taken.
Stock markets worldwide have reliably rewarded long-term investors. For example, over the past eighty years, investors who held the S&P 500 (including dividends) for at least 12 years would always have had positive returns.
Commodities, like many things that come out of Wall Street are easy to sell and hard to trust. Though the Commodities market is sometimes in vogue, they are too volatile to be held for the long-term. According to a Goldman Sachs Group Inc. study from 2016, a portfolio of stocks, bonds and commodities showed a worse return in the period from 1987 to 2015 than a portfolio of just equities and debt. They also may not be a good hedge during stock market declines: Commodities fell more than U.S. equities during the recent stock market declines in 2008, 2010, 2011 and 2015.
Why don’t commodities cut it?
Technology. New technology has created some of the world’s largest companies. The profits made by companies like Amazon, Apple, Facebook and Google have turned into soaring stock prices for those companies. When it comes to commodities, technology is frequently used to make things more streamlined, more efficient. With efficiency come lower costs. Thus, many commodities may experience a downward bias in prices because of technology.
Users. When it comes to stocks, prices are driven by investor expectations. With commodities there are disparate parties involved in determining the prices and when they may rise and fall. If a farmer has a surplus of crops, they still need to be sold, thus the farmer may drop his price to encourage buying activity.
Boom/Bust: Since we live in a world where maximizing production is practically ingrained in our DNA, the cycle of significant price fluctuation in commodities is inherent. High prices encourage overproduction, leading to an oversupply of a commodity, leading to the driving down of prices, leading to reduced production, leading to an undersupply and the cycle continues.
Physical Space. When you buy a commodity, you are buying something that takes up actual physical space. This is very different from a stock or bond. Things that take up space need to be moved, stored and insured. There are costs for that.
Implementation expenses. Commodities investment products like mutual funds or ETFs have higher expenses than stock index funds.
Past history. As we all know, past history does not guarantee future performance in any investment. That being said, many investors have had poor returns in commodities. The Bloomberg Commodity Index has had negative annualized returns over one, three, five, ten years, and barely positive over 15 years, ending April 2017. See table below.
Redundancy. Many publicly traded companies hold commodities as a routine part of their business, for example oil or mining companies. Investors considering a separate investment in commodities are likely getting just an “extra helping” of an asset they may already have exposure to.
Why Do Some Think Commodities Still Have a Place at the Table?
This gets us back to the difference between gambling and investing. For some, investing is more about putting money on the hot horse than it is about using research and analysis to make the best decisions for the long term return on a portfolio. Taking risks is the nature of investing, but risks can be taken on investments with a much higher probability of more consistent, less volatile return than commodities have demonstrated.
So—can commodities make money? Yup. Sometimes. So can lottery tickets. But you shouldn’t bet your retirement on it.