A Case Against Commodities

A decade or so ago a couple of papers circulated in the investment world. The papers argued that commodities were a great diversification tool in a portfolio, because they tend to move inversely to stock prices yet over full cycles had very similar returns to stocks. The papers drew a few critics at the time, based largely on technical points and the use of futures prices in the papers instead of spot prices of commodities. Experience has been the biggest obstacle to the theory. In recent years, especially since the financial crisis, commodities and stocks generally moved together.

Now, there’s a more substantive paper arguing that there is a high correlation between stocks and commodities, so there isn’t much of a reason to include both in a portfolio. It’s a somewhat technical, academic paper. You can read a summary and highlights here.

Private and institutional investors have displayed an increasing appetite for commodities over the past years. Our findings have far-fetching policy implications in this respect. On one side, our results provide empirical support for the inclusion of commodities in a portfolio. At the same time, however, we have also found that this comes at the cost of an increase in volatility. Therefore, the growing appetite for commodities is likely to produce more volatile portfolios. Digging further into the financial stability implications of the increasing correlation of commodity and equity returns is a relevant subject for future research.