Commodities: An Investment Framework, Part I
(6 min read)
Global commodities prices have recently declined sharply, along with a general ‘risk-off’ trade in financial markets. But commodities were already in a multi-year downtrend prior to recent developments and have generally performed poorly since 2011. In this, Part I of a series on commodities investing, I provide a framework for understanding what commodities are, what they are not, and whether and how they could or should be included in a diversified investment process. In brief, I believe commodities can play an important role, but not the role most popular with investors in recent years.
Commodities as an Asset Class (or ‘Anti-Asset’ Class)
So what exactly are commodities? Commodities represent the raw inputs into economic goods. As such their prices, driven by supply and demand, are normally caught in the business cycle to an even greater extent than the equity or bond markets. This is due to their raw nature. They do not represent a claim on a long-term stream of cash flows across one or more business cycles, as most securities do, rather merely the immediate value they provide as an economic input factor. Therefore, it is a stretch to consider commodities an ‘investment’ at all and, for those not naturally exposed to commodities prices, buying or selling commodities appears more akin to speculation rather than something that should be considered a core, strategic part of a robust, diversified investment process.
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