Are Commodities Right For Your Retirement Portfolio?

Higher prices returned with a vengeance in 2021. During such bouts of inflation, commodities tend to do well. Last year the S&P Goldman Sachs Commodity Index (GSCI) earned 37.1%, far exceeding the S&P 500 and all other equity indices. It was the third best-performing asset class in 2021. Indeed, only Bitcoin (59.8%) and WTI Oil (56.4%) yielded more according to TradingView.

But are commodities really appropriate long-term investments? Are they right for your retirement plan?

Some view them as an essential category in a portfolio’s asset allocation. Others see them as nothing more than merely just another game in the market timing casino.

Last year’s returns were no fluke. There’s no question commodities outperform when inflation strikes. There’s a good reason for that.

“Energy and food are more than 20% of headline CPI,” says John Ingram, CIO and Partner at Crestwood Advisors in Boston. “The measurement of commodity prices and CPI overlap, so they move together.”

But the link goes well beyond these more well-known items.

“Commodities generally do well during times of inflation because the underlying goods and services that make up the commodities sector tend to also see a rise in price,” says Kyle Whipple, Partner at Custom Wealth Solutions in Plymouth, Michigan. “Most of these resources that make up the commodities sectors are going to offer the same benefit regardless of where that particular resource originated, so generally you’ll see prices increase across the board on a particular good. Who produces it and where doesn’t make as much of a difference. When inflation increases the cost of goods (as we’ve seen) and demand remains high, it pushes the prices of commodities up.”

Because of this correlative relationship, it’s natural to include commodities within the palette of assets you might want to consider incorporating into your portfolio.

“Commodities can be viewed as another asset class when seen as a way to take advantage of inflation, whereas many other asset classes (albeit not all) are negatively affected by inflation,” says Daniel Milan, Managing Partner of Cornerstone Financial Services in Southfield, Michigan. “It’s almost like an inflation hedge asset class in some scenarios.”

On the other hand, the buying and selling of commodities doesn’t feature the same kind of fundamental analysis that stocks and bonds do. In this way, it’s almost like rolling the dice. Do you feel lucky?

“Commodities don’t produce anything the way traditional investments do (i.e., profit, dividends, rent),” says Asher Rogovy, Chief Investment Officer for Magnifina, LLC in New York City. “Any profit from trading commodities comes at the expense of other traders. It’s a zero-sum game.”

In this sense, if you trade commodities it can seem like you’re trying to time the market. Everything depends on your ability to guess correctly.

“As commodities have no yield or earnings that can compound, positive commodity returns are dependent on rising prices during your holding period,” says Ingram. “Unfortunately, commodity prices are very hard to predict. For example, investors spend a lot of time trying to predict the direction of energy prices, with little sustained success. It is best to remain skeptical of price forecasts, as many hard-to-know factors influence prices, including investor speculation.”

Holding for the long term, however, can often mitigate the dangers of market timing. Can commodities do that for you in your retirement account?

“While commodity prices may be volatile in the short-term, they revert to an equilibrium level relative to their value to businesses over the long-term,” says Rogovy. “Businesses, on the other hand, grow over the long-term. They reach new markets, develop new products, and increase the efficiency of their own operations. Additionally, stocks are known to provide protection against inflation over the long-term.”

It’s clear professionals hold different opinions on the question of placing commodities in long-term portfolios.

“As discussed earlier, commodities are a hedge against inflation,” says Whipple. “Holding commodities or specific commodities (like precious metals) might be more suitable for a short-term period if you are short-term profit driven. During inflationary spikes, as we’ve seen over the last year, the commodities market can see a sizable increase. Reallocating to a larger amount of commodities during a short-term period may help meet the goal of short-term profit. You must be aware that the shift can turn just as quickly. Long-term exposure might be better kept to broad-based commodities ETFs or funds so that your portfolio isn’t too heavily correlated to one specific good or resource.”

But does the “index of commodities” bear up well against typical long-term investments. It doesn’t appear so.

“Commodities carry similar volatility as risk assets like stocks,” says Ingram. “Over the past 21 years, investors would have gained far more wealth invested in a portfolio of stocks. During this period, the Bloomberg Commodity Index, a diversified basket of commodity futures, returned just 24.9%, while the S&P 500 returned 345%. This return history tells us that buying commodities is at best a short-term strategy that requires you to accurately predict future commodity prices.”

You may read the headlines and think commodities ought to have a slot in your portfolio’s asset allocation. That’s up to you. It’s important, though, that you understand exactly what you’re getting into.