Here is a chart of the Reuters/Jefferies CRB Index which plots monthly returns from 1956 through the present (February 29, 2008 is latest data point). You can see that since February 28, 2002, the commodities index has been on an absolute tear, going almost straight up. In the past couple years, when stocks have not been doing so well, the continued rise in commodities has many investors asking "What about commodities for me?"
You may even be asking yourself (or hearing someone asking you) "What about commodities?"
However, if you look more closely at the long-term record of this commodities index, you will see that the index goes up and down quite reliably, but it doesn't ever really go anywhere. See the chart below:
Commodities may be "hot" at the moment, but even with the tremendous run-up in commodities over the past few years, commodities are NOT a money-making long-term investment. In fact, as you can see from the chart above, the thirty-year track record works out to an annual rate of return of only 2.41% per year -- well below inflation of approximately 4% per year for that particular thirty-year period (according to the CPI website).
Going back twenty years, you can see that the annual rate of return over the past twenty years was only 3.06% -- barely above the average inflation rate of 2.95% for that twenty-year period. (Note also that the annual rate of return between February 1978 and February 1988 was a mere 1.11% per year for ten years).
This aspect of commodities should be well-known to the investing public, and yet it seems that every time stocks are in a slump and commodities are rising, the "conventional wisdom" dictates "investing" some portion of your capital in commodities.
Unlike stocks, which represent a share in a business, commodities are the essence of a zero-sum game. By their very definition, a commodity is something to which no value has yet been added -- it is a "raw material".
Therefore, it is not surprising to learn that you cannot simply "buy commodities" and hold them for thirty years and stay ahead of inflation. You can do that in a company that continues to add value to its customers for thirty years, but you cannot do that in a commodity, which is a non-value-added entity. The only way to make money in commodities is illustrated in the chart below:
Commodities are a perfect example of a "trading vehicle" rather than an investment vehicle. We explained the difference in an earlier post, entitled "Gambling, Speculation, and Investment."
Incidentally, although it is quite clear that the strategy depicted in the above slide is a trading strategy that relies on making the right call on when to get in and when to get out (very difficult to do), many people take the exact same approach to their stock portfolio and think that they are "investing" when in fact they are following a trading strategy.
That's because the general marketing machines of Wall Street and the financial media have conditioned investors to think that they need to substitute the above slide for one sector or another: BUY the energy sector! SELL the tech sector! BUY defensive stocks! SELL small-cap stocks! BUY the tech sector again! SELL the energy sector!
This is not investing -- it is trading, which is generally a form of either speculation or gambling. As we explained in our very first post, we believe in the exact opposite. The majority of the big fortunes of this country, whether in the past twenty years or the past one hundred years, were made by the ownership of shares in companies which added value over a long period of time.
[As a footnote, gold is one commodity which has served as a "store of value" for centuries, and it has done better than the overall CRB commodities index -- lately. For example, the precious metals sub-index of the CRB increased by an annual rate of return of 6.35% over the past 30 years, although it was generally flat until 2003 when the Fed decided to lower the funds rate to 1% for over a year; at that time precious metals took off. That still falls well behind the 9.52% annual rate of return of the S&P 500 for the same 30-year period -- and that doesn't even count the dividends over that period. Furthermore, as we have already discussed in this post, for long periods of staying ahead of inflation, nothing comes close to stocks: see the graphs and discussion by Jeremy Siegel here. Prior to 2003's explosion, the precious metals index had just finished a twenty-year period in which its annual rate of return was negative 0.78% per year for twenty years, meaning that even with precious metals you still have the problem of timing, otherwise known as speculation or gambling].
For later blog posts dealing with this same subject, see also:
However, if you look more closely at the long-term record of this commodities index, you will see that the index goes up and down quite reliably, but it doesn't ever really go anywhere. See the chart below:
Commodities may be "hot" at the moment, but even with the tremendous run-up in commodities over the past few years, commodities are NOT a money-making long-term investment. In fact, as you can see from the chart above, the thirty-year track record works out to an annual rate of return of only 2.41% per year -- well below inflation of approximately 4% per year for that particular thirty-year period (according to the CPI website).
Going back twenty years, you can see that the annual rate of return over the past twenty years was only 3.06% -- barely above the average inflation rate of 2.95% for that twenty-year period. (Note also that the annual rate of return between February 1978 and February 1988 was a mere 1.11% per year for ten years).
This aspect of commodities should be well-known to the investing public, and yet it seems that every time stocks are in a slump and commodities are rising, the "conventional wisdom" dictates "investing" some portion of your capital in commodities.
Unlike stocks, which represent a share in a business, commodities are the essence of a zero-sum game. By their very definition, a commodity is something to which no value has yet been added -- it is a "raw material".
Therefore, it is not surprising to learn that you cannot simply "buy commodities" and hold them for thirty years and stay ahead of inflation. You can do that in a company that continues to add value to its customers for thirty years, but you cannot do that in a commodity, which is a non-value-added entity. The only way to make money in commodities is illustrated in the chart below:
Commodities are a perfect example of a "trading vehicle" rather than an investment vehicle. We explained the difference in an earlier post, entitled "Gambling, Speculation, and Investment."
Incidentally, although it is quite clear that the strategy depicted in the above slide is a trading strategy that relies on making the right call on when to get in and when to get out (very difficult to do), many people take the exact same approach to their stock portfolio and think that they are "investing" when in fact they are following a trading strategy.
That's because the general marketing machines of Wall Street and the financial media have conditioned investors to think that they need to substitute the above slide for one sector or another: BUY the energy sector! SELL the tech sector! BUY defensive stocks! SELL small-cap stocks! BUY the tech sector again! SELL the energy sector!
This is not investing -- it is trading, which is generally a form of either speculation or gambling. As we explained in our very first post, we believe in the exact opposite. The majority of the big fortunes of this country, whether in the past twenty years or the past one hundred years, were made by the ownership of shares in companies which added value over a long period of time.
[As a footnote, gold is one commodity which has served as a "store of value" for centuries, and it has done better than the overall CRB commodities index -- lately. For example, the precious metals sub-index of the CRB increased by an annual rate of return of 6.35% over the past 30 years, although it was generally flat until 2003 when the Fed decided to lower the funds rate to 1% for over a year; at that time precious metals took off. That still falls well behind the 9.52% annual rate of return of the S&P 500 for the same 30-year period -- and that doesn't even count the dividends over that period. Furthermore, as we have already discussed in this post, for long periods of staying ahead of inflation, nothing comes close to stocks: see the graphs and discussion by Jeremy Siegel here. Prior to 2003's explosion, the precious metals index had just finished a twenty-year period in which its annual rate of return was negative 0.78% per year for twenty years, meaning that even with precious metals you still have the problem of timing, otherwise known as speculation or gambling].
For later blog posts dealing with this same subject, see also:
- "What about commodities -- revisited" 09/02/2008.
- "A conversation with Gerry Frigon" 08/10/2009.
- "The 97-pound weakling" 12/16/2009.
- "Avatar and long-term inflation" 03/02/2010.
- "Gold versus Apple" 10/25/2010.
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