Everyone uses commodities such as wheat, cocoa, crude oil, butter, coal and electricity. But most investors know that speculating on commodities in the futures markets is only for the pros, and no sensible amateur would bet his retirement or college funds on sugar, silver, orange juice or feeder cattle. One of the most infamous commodities investments, pork belly futures, is shorthand for "how to lose your nest egg in the wink of an eye."
But are commodities really that risky? A shortage of data has left that question unanswered. Until now. Using the most comprehensive data on commodities futures returns ever assembled, Wharton finance professor Gary Gorton and K. Geert Rouwenhorst, finance professor at the Yale School of Management, have reached a surprising conclusion: Commodities offer the same returns as investors are accustomed to receiving with stocks, which are typically viewed as safe enough for ordinary investors. "That was quite startling to many people around the world, both in academia and outside academia," Gorton said. "They thought it would be lower."
Commodities are, in fact, not as risky as stocks, according to Gorton and Rouwenhorst, who recently completed a paper on this topic titled, "Facts and Fantasies about Commodity Futures." Most important, commodities are "negatively correlated" with stocks and bonds, meaning their prices tend to rise when stock prices fall, and vice versa. This is largely because commodities tend to do well when inflation is high, while stocks and bonds do not.
That would make a commodities portfolio ideal for diversifying, or spreading risk among various types of investments. "When it's raining in the equity markets, the sun is shining in commodities futures," Gorton said. "On average, when one is going up, the other is going down....One safe thing that I would be willing to conclude from our study is that no institutional investor should have zero allocated to commodities futures.
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