Ben Carlson has been nailing it lately over in Tumblr-ville on the new Yahoo Finance Contributor network. There was him pointing out the issues with using risk adjust returns, then some stats showing even Warren Buffet has had some very big Drawdowns… (consider that all of you who pull the plug at the first sign of trouble in the alternative investment world), and the one that most caught our attention – “Are Commodities for Trading or Investing?”

The commodities piece was right up our alley, being in the business, so to speak. The piece echoes some of what we said in our newsletter last year: “3 Big Reasons Commodity ETFs aren’t Getting the Job Done,” which is basically that commodity ‘investing’ doesn’t look so great when it is a “long-only“ approach (only makes money when commodities go up) because:

1. Commodities don’t always go up (e.g. iShares GSCI ETF (GSG) -37% since inception in ’06),
2. Even when they do, they are very volatile,
3. Even when they do, the access points are complex and won’t necessarily provide a return equal to what the commodity did.

Carlson goes a step further, however, quoting some academic research which shows commodities actually add volatility and reduce return… not reduce volatility and add return as is supposed to be the case with a non correlated investment.

So trade commodities instead of ‘invest’ in them?

Now, some might take that to mean that commodities should be avoided, and here’s where it gets a little confusing – because the lesson from this shouldn’t be that ‘commodities’ are to be avoided and that ‘commodities’ add volatility and reduce return.  The lesson should be that Long-Only Commodities do those bad things. The lesson should be that diversification into the commodities space isn’t as simple as buying and holding those volatile commodities. The lesson might be that they are better for ‘trading’, as Carlson points out, then ‘investing’.

Trading commodities can still give you exposure to moves that have nothing to do with the stock market (like Coffee being up 71% this year or grains selling off 30% the past few months). And that’s really what having exposure to commodities is all about. It’s about gaining exposure to outlier moves in commodity markets brought about by non-financial, non economic catalysts. Like droughts and snow storms.

But not everyone wants to sit around and ‘trade’ commodities. That’s not quite a retirement plan… “I put 40% in stocks, 30% in bonds, and trade 30% in commodities”… as it would cut into your golf time quite a bit.  For those who still want the commodity exposure, but not the trading screens – the target is professional commodities traders, or registered Commodity Trading Advisors.  Now, there are thousands of such registered professionals out there – but the grand majority of them don’t actually trade in commodities, despite their name. The grand majority do systematic trading on a portfolio of markets including bond, currency, and stock index futures.

The ones which trade commodities and commodities only – are what we call Ag Traders (short for Agriculture). So while Mr. Carlson’s question seemed to be of the rhetorical type – we can actually put some data to it and compare professional commodity trading with commodity investing via ETFs. Who wins?

Investing in the ‘trading’ of commodities versus just plain ‘investing’ in commodities has won out handily over the past 9 years. [Past performance is not necessarily indicative of future results].

(Disclaimer: Past performance is not necessarily indicative of future results)
(Data= BarclayHedge Ag Traders Index, GSG = iShares GSCI Commodity Index)

For more on how these professional commodities traders operate, download our whitepaper detailing Agriculture (or Ag) Traders.