Oxford dictionary define a commodity as ‘A useful or valuable thing’. Another definition they put out there is ‘A raw material or primary agricultural product that can be bought and sold, such as copper or coffee’. Whichever way you look at it, be that a useful and valuable thing, or indeed a basic product, Commodities have found their way into many many pension and investment portfolios.
Apparently as many as 4,000 years ago our Neolithic ancestors here in Ireland made use of cattle, for food, leather and indeed milk. Many of you reading this may never have milked a cow, however you may well own a very tiny portion of a fund which tracks the price of those fine animals!
Chances are, if you are a member of a company pension scheme, or have some spare money invested, you are investing in Commodities, whether you know it or not! As strange as it may sound cattle prices are frequently an aspect of Commodities in investment terms, so you could well have an active interest here!
We are going to look at the pros and cons and alternatives to investing in Commodities, either as a lump sum investor or a pension investor here in Ireland.
As always, we want to express our thanks for visiting our wee site and reading this blog, all we hope is that it is informative, useful and potentially will give you renewed confidence in Financial Planning/Financial Advice in Ireland (this is not advice by the way, just so we’re clear on that!!). By all means check out our reason for being here, we’re sort of on a mission, a vocation some might call it!
What Exactly Are Commodities?
When it comes to investing we here firmly believe that long term investment success comes from keeping it simple, from investing in a well diversified equity portfolio. Nothing has proven to deliver greater returns to regular investors over the long term, nothing. When one invests in such a portfolio they are ultimately purchasing portions of potentially thousands of individual companies, companies which create services and products, which expand and strive to continuously create more products and services, and ultimately more and more profit. Commerce and competition drive them forward on the constant upward curve. It is this drive to create and grow which fuels the value of owning a portions of such a portfolio. But we are here to talk about Commodities……Commodities are very different, they are the product! Products in and of themselves do not grow, do not strive to generate output, to create value and deliver long term returns for investors. As we all know products are bought and sold at varying prices based on it’s value to the purchaser.
Typically when you have a portion of Commodities in your pension or investment fund you will see that the commodities fund will contain elements of the likes of Oil, Gas, Copper, Cattle, Gold & Grains.
Interestingly, sort of anyway, is the fact that if you own Commodities through a fund, investment or pension, usually the Commodities are not owned directly, the fund manager will be buying and selling agreements to buy and sell them at future points in time. They imaginatively enough call these agreements ‘Futures’. It stands to reason in fairness ,as most Fund Managers don’t want to have to have a delivery truck full of Oil, Gas or indeed Cows arrive at the office in Grand Canal Dock or wherever they’re based every-time they purchase some Commodities!
The price of the given Commodity Future will rise and fall based on the market value of the actual product, naturally enough. However, because they are being bought and sold through Futures, the quoted price on your Commodity Fund will often also be determined by the exchange rate movements between the currency of the Future (Dollars, Pounds etc) and the Euro. These prices are also hugely subject to a thing called ‘roll yield’ which could be described as the net benefit or indeed net cost of owning the product, beyond movement in it’s actual market price. It’s bizarre but that the facts of Commodity ownership!
The Benefits Of Investing In/Holding Commodities:
- Commodities can deliver huge growth potential over the short term. In 2010, Gold, to pick just one Commodity, grew in value by over 30%. You might recall ‘Cash For Gold’ stalls popping up in every Shopping Centre in the country back then. Bring in your dead grannies gold watch and they’d give you €50 for it based on the weight of gold. I’m sure only to sell it on for 10 times the price paid! Where are the ‘Cash For Gold’ stalls now I ask!
- Traditionally it was felt it when Equity/Share prices fell that Commodity prices grew, and vice versa. This would mean that owning both would give you a less volatile investment return over the long term (but hold that thought till point 2 below!)
- They allow one to diversify their portfolio. They are another asset class in which to invest, as opposed to investing all your eggs in the one basket
- They enable you to try to sound cool at a party or in the work canteen when you can tell associates ‘I invest in Commodities don’t you know!’ (We are scrapping the bottom of the barrel you see!)
The Downfalls of Investing In/Holding Commodities:
- While they can deliver short term gains there long term returns are atrocious. If you are an investor looking to benefit from the long term growth rates of an asset class this is not the one for you! While they offer the same level of volatility as equities, the return they give to investors over the long term is only on a par with long term inflation (approx 2%, versus approx 9% from equities!)
- Recent research, such as this by BIS, is showing that in the most recent decade Commodity and Equity prices rise and fall together, as opposed to inversely like traditionally was believed. Therefore Commodities are said to offer little or no benefit in regards smoothing the investment journey
- Commodities are another asset class, no denying that, however they offer rubbish return over the long term. For example, this total commodity fund from 1991 to 2015 returned just over 2% per year.
- The level of volatility involved with Commodities, such as the gold example above make Commodities appealing to investors from time to time. It is a real case of jumping on the band-wagon when they are rising in value. This is a strategy in which the majority of us are destined to fail over the long term. However, because they have the occasional purple-patch they will I’m sure continue to be considered a suitable long term investment for those looking for growth, which they have largely proved themselves absolutely not to be!
- Gold, oft hailed as that wonderful investment, from 1980 (the year yours truly was born!) to 2016, delivered an annual rate of return on average of less than 2.5%. The S&P 500 (US diversified equity Index) returned on average of just under 11.5%, per year.
We here encourage others to consider their financial future and their financial planning as a long term game. The same can be said of our outlook and philosophy when it comes to investing. Any short term investment is purely speculation. If you were born in 1980, like I, and you had the choice of getting a gold bar, an equivalent stake in the S&P 500, or a cow, we all know which one would be of the greatest value right now (hint, it ain’t the gold and it ain’t the cow!).
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