Author Topic: Commodities, Risk and Return  (Read 2290 times)

steevven1

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Commodities, Risk and Return
« on: March 16, 2016, 02:53:44 PM »
To me, it SEEMS like commodities, particularly oil and gold, are high-risk (same or bigger daily volatility than stocks on average), low-return (3% or so annually over long terms) assets. Correct me if I am wrong on that, but that has been my observation.

If you don't have an objection to that premise, then can you explain why this is the case? Aren't higher risk assets supposed to pay better in the long run? Shouldn't the market price them according to their risk? Is there something fundamentally different about these that justifies their higher risk-reward ratio? Is it because there is a non-investor market for commodities (as opposed to stocks, bonds, etc.) which truly sets the price, and that price is higher than what would be expected for an investment with similar risk and return potential?

I think my last question is the key, maybe. Would love to hear more on this though.

MustacheAndaHalf

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Re: Commodities, Risk and Return
« Reply #1 on: March 16, 2016, 09:28:23 PM »
You can't drive to work by feeding stock certificates into your car - but oil can get you through your commute (after being processed onto gasoline).  Commodities have alternative uses, like fueling cars or becoming breakfast.  Without any speculators, commodities still have value.  So your premise is that both stocks and commodities are 100% investments, but that's not the case.

For example, a really big food company might buy pork bellies - and actually take delivery.  They're buying goods, not speculating on price.  But to invest in commodities, you can't have the physical goods show up at your door.  You need to buy at one price and sell at a higher price, with no income while you hold it.  Commodities are different from stocks in ways that do not fit a pure risk and return analysis.

Another example: a really badly run mutual fund has additional risk, with no additional return.  I think studies of reversion to the mean (best become average, worst become average) show that some badly performing mutual funds keep performing badly.  Some investments have additional risk for which you are not compensated.
« Last Edit: March 16, 2016, 09:33:50 PM by MustacheAndaHalf »

nobodyspecial

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Re: Commodities, Risk and Return
« Reply #2 on: March 16, 2016, 10:36:30 PM »
Commodities aren't investments, they offer no return and are simply gambling.
Roulette also offers low returns for significant risk

steevven1

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Re: Commodities, Risk and Return
« Reply #3 on: March 17, 2016, 09:29:33 AM »
So, is everyone just in agreement that commodities are high-risk and low-return investments (on average), and that long-term investments in commodities are strictly bad?

NorCal

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Re: Commodities, Risk and Return
« Reply #4 on: March 17, 2016, 12:09:07 PM »
Long term investments in commodities are bad.  Since the associated investment vehicles are in futures, the roll-yield will destroy your portfolio over time.

There are some momentum based commodities strategies that do work, and can be part of a sophisticated portfolio.  These strategies have value as a part of a portfolio because of they have a low correlation to traditional equity/bond portfolios.  I wouldn't recommend these for individual investors unless you have a deep understanding of statistics or related higher math. 

Gold does have value as a small part of a portfolio.  The reason to have gold in a portfolio isn't because you should expect high returns from it.  It is because gold has a strong negative correlation to equity's.  Diversification is the only free lunch in investing (proven by Modern Portfolio Theory) and it's good to take advantage of it.  I have about 3% of my taxable portfolio in gold.  However, in truth, the difference between having a tiny stake or no stake is pretty small.  So only buy it if the added complexity is worth it to you.

steveo

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Re: Commodities, Risk and Return
« Reply #5 on: March 17, 2016, 02:34:10 PM »
I think commodities can play a part in your asset allocation to reduce volatility. I think that there are 3-4 broad asset classes - stocks. bonds/cash, real estate and commodities. Commodities don't really earn any income whereas the other asset classes do. They do though have booms and busts which tend to not be in line with the other asset classes.

So if you want to increase diversification to reduce your overall volatility then commodities may be able to play a role.

Metric Mouse

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Re: Commodities, Risk and Return
« Reply #6 on: March 18, 2016, 12:08:41 AM »



But seriously: doesn't that 3% a year mirror inflation, thus serving as hedge? This could be the real role of commodities in a portfolio.
« Last Edit: March 18, 2016, 12:10:27 AM by Metric Mouse »