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Should You Invest in Commodities?

By James K. Glassman
Kiplinger’s Personal Finance

It's an old story but easy to forget: When inflation expectations rise, so do interest rates – and stock and bond prices fall. For the first time in five years, the consumer price index in 2017 registered an annual increase of more than 2 percent, and prices rose more than expected in January. The January jobs report showed a jump in wages.

Inflation has yet to reach worrisome levels, but the stock market dropped sharply after each sighting, with investors worried that the Federal Reserve would start aggressively raising short-term interest rates. (It raised its benchmark funds rate in March to a range of 1.5 percent to 1.75 percent, and signaled two more rate increases may be coming later this year.)

Maybe it's time to invest in a hedge, an asset that will buffer a decline in stock values: commodities. Research shows that investments in crops, metals, energy, currencies and other tangible things are negatively correlated with both stocks and bonds. When one group goes up, the other group tends to go down. This inverse relationship is not perfect. If economic growth slows sharply, stock prices typically fall, but the demand for oil, copper, corn and such slows as well, so commodity prices fall, too. If the U.S. were to slide into a serious recession, commodities would almost certainly get crushed. Over the course of the 2007-09 recession, for instance, commodities dropped 40 percent – even more than stocks did.

In a growing economy, however, commodities do provide protection against the ravages of inflation.

One way to buy commodities is by purchasing an exchange-traded product, which is linked to an index. For example, PowerShares DB Commodity Tracking (DBC) mimics a Deutsche Bank index; it holds a mix of two dozen futures contracts maturing this year and next, including gold, natural gas, soybeans and wheat. The fund carries an expense ratio of 0.85 percent. In a vivid display of negative correlation, while the average annual return of the S&P 500 was 14.8 percent over the past five years, the fund returned -10.2 percent.

Another popular choice, iPath Bloomberg Commodity Index Total Return (DJP), is structured as an exchange-traded note (ETN). Instead of paying interest, the ETN provides returns linked to the performance of the underlying index. That Bloomberg index, in turn, is composed of several subindexes. The ETN is tilted toward energy and grains. It returned an annual average of -9.9 percent over the past five years. The expense ratio is 0.70 percent.

As stocks have gone up and up during the bull market, the performance of these commodity funds has been rotten. With the exception of a decent 2016, the commodities drought has continued for seven years. But if you believe the stock market is entering its own drought, investments in commodities could provide some fertile soil for your portfolio.

Editor’s Note: James K. Glassman is a contributor to Kiplinger's Personal Finance magazine,

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