Hard Assets

Commodity investments can be hard assets to figure out. The value of the dollar impacts their price. Oil, for example, is quoted (priced) in dollars. If the value of the dollar declines relative to other currencies, but world demand remains constant, then the price of oil will go up – all other things being equal. So a weak dollar stokes energy industry profits. On the other hand, energy is a key input for industrial commodities, like aluminum. As energy prices rise, so do manufacturing costs; profit margins in the aluminum industry can get squeezed.

The Scout Partners (now May-Investments)investment process often looks at commodity investments as an alternative to traditional stocks. In 2001-2002, while the U.S. stock market was losing 33% of its value, commodity stocks were off only modestly and managed futures portfolios were typically appreciating. Investors who employed a flexible asset allocation approach could have side-stepped parts of the bear market and employed their capital much more effectively by considering a wider range of asset classes.


The Scout Partners' ETF model follows two commodity-based ETFs at the moment, though many more exciting options are coming to market as the ETF industry matures. The iShares Natural Resources Index Fund (IGE) tracks stocks represented in the Goldman Sachs Natural Resources Index, including companies in extractive industries, energy companies, owners and operators of timber tracts, forestry services, producers of pulp and paper, and plantation owners. We also use the State Street Materials SPDR (XLB), to represent the domestic basic materials industry – as part of the U.S. stock market. However, the natural resources index (IGE) is more energy intensive than we’d prefer. There’s too much overlap between IGE and the domestic energy portfolio (XLE).

In time, we would expect to find a commodity-based ETF that is more broadly based with less energy exposure and a lower correlation with the U.S. stock market.

The innovative ETFs coming to market will provide us with a better option, but next month we’ll take a look at why investors need to look closely before adding just any ETF to their portfolio.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

Go to Investments main page.