Commodities ETFs Want To Get Back Into Your Portfolio

During the halcyon days of quantitative easing, dollar weakness and inflation expectations, commodities exchange traded products were hits. Just five years ago, there was $125 billion in assets under management across commodities exchange-traded funds and exchange traded notes (ETNs) and there was a time, albeit brief, when the SPDR Gold Trust (ETF) GLD was the largest ETF in the world.

Over the past year, commodities ETFs have been beset by dismal performances and massive outflows, prompting some investors to question the value of commodities as core portfolio holdings, even in modest allocations.

What Commodities Are Doing

While the PowerShares DB US Dollar Index Bullish UUP, the U.S. dollar index tracking ETF, has climbed 9.3 percent over the past year, commodities ETFs have been decimated. For example, GLD and the iShares Silver Trust (ETF) SLV have posted an average loss of 6.5 percent, while the United States Oil Fund LP (ETF) USO has plunged 53.4 percent. Outflows have come along with those troubling showings.

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“Consider that at the end of 2005, there was less than $5 billion invested in U.S.-listed commodity ETPs. About five years later, after a period of exponential growth, assets in commodity ETPs topped out around $125 billion. By this time, investors started to learn about terms like contango and backwardation, realizing that they needed to adjust their expectations.

“Since topping out in August 2011, commodity ETP assets have been in decline thanks to negative returns and sharp redemptions. Investors have yanked more than $22 billion out of commodity ETPs over this period,” according to Morningstar.

Where's The Dollar Now, And What's That Mean Thesis-Wise?

With some market observers noting that the dollar's strength is still in the early to middle innings, a large part of the bullish thesis for commodities has been eroded. Further erosion is found when evaluating data that suggest commodities are not as negatively correlated to bonds and equities as the asset class once was.

Looking At Commodities

As Morningstar noted, a study by professors Gary Gorton and Geert Rouwenhorst highlighted disappointing correlation data for commodities futures.

“The results speak for themselves: Over the past 15 years, an allocation to commodities has generally resulted in lower returns and greater risk,” according to Morningstar.

Commodities ETFs still have utility as trading vehicles. Traders that know USO can be vulnerable to contango can still use the ETF as a short-term trading vehicle and plenty do. And as recently reported, no ETF has benefited from the Volkswagen AG (ADR) VLKAY scandal on par with the ETFS Physical Palladium Shares PALL.

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However, what long-term investors should concern themselves with is long-term, risk-adjusted returns – and that outlook is bleak for commodities because, as Morningstar's data indicate, portfolios including commodities result in lower Sharpe Ratios than traditional 60 percent equity/40 percent fixed income portfolios.