Commodities: Beyond Pork Bellies

By Amey Stone –
Surging prices in staples such as oil, gold, and corn are catching investors’ eyes. The rewards can be great, if you know how to play
Although commodities investing is pretty much the same as it always has been, you sure wouldn’t know it from the buzz these days. It’s suddenly one of the hottest areas on Wall Street, thanks to the surge in crude-oil prices, as well as continued gains in the likes of gold, copper, corn, and soybeans.

“I’ve advocated that investors should have some exposure to commodities for the last 25 years,” says Bob Greer, who designed the first commodity index fund in the 1970s and is now a vice-president at mutual-fund company PIMCO. “Now it seems like the world is finally catching up with that view.”
Investor Jim Rogers, whose 2003 book Adventure Capitalist (a follow-up to his 1994 bestseller Investment Biker) predicts a multiyear bull market in commodities, says new academic research proves his long-standing belief that commodities offer higher returns and less risk than stocks. “The only reason they got such bad press is because everybody has some uncle who lost his shirt buying pork bellies on 5% margin,” he says.
SOPHISTICATED PLAYS. Of course, plenty of alternatives to that risky game are available. Already investors’ new ken for commodities has amounted to a booming business for commodity trading advisers (CTAs), which trade in futures markets. Basically a breed of hedge fund, CTAs (also known as managed futures funds), can be high-risk with high minimums, as much as $1 million, to boot.
Exchange-trades funds (ETFs) are another way some sophisticated investors are playing in commodities. Scott Fullman, an options specialist and chief strategist at Investec U.S., points to much recent interest in ETFs such as the Oil Service HOLDRs Trust (OIH ) and AMEX Gold Bugs Index (HUI ). “It’s a combination of hedging and just plain speculating,” he says.
That doesn’t mean the average investor can’t find a good commodity fund to buy and hold, argues Rogers. It’s no surprise that his choice is the Rogers International Commodities Fund, a limited partnership with a $10,000 minimum that’s based on an index Rogers created. The index gained 32% in 2003 and is up 22% year-to-date, according to information at
GLOBAL TREND. Investors more comfortable with a traditional open-end mutual fund have just a couple of established choices. Even with these more conventional choices, investors should just dip their toe. Greer says most investors keep just 3% to 5% of their total portfolio in commodities.
PIMCO Commodity Real Return Strategy (PCRAX ), is by far the largest commodity fund with $5 billion in assets. It invests in a index that caps energy holdings at 33%, so it also provides broad exposure to gold, soybeans, cocoa, industrial metals, and other commodities. It’s up 11% in 2004 so far, after gaining 29% in 2003.
Greer sees increasing demand for commodities coming not just from infrastructure build-outs in China and India (a much-hyped story) but also from a global economy that’s developing a higher standard of living for millions more people. “What we’re seeing is a result of not just a one- or two-year spike, but 20 years of underinvestment in the infrastructure for commodities,” he says.
DEEP INTO ENERGY. Due to bottlenecks in producing, storing, and transporting many commodities, he expects future supply shocks that will drive prices higher. “We cannot predict when the surprises will come,” says Greer. But as we’ve seen this year, the kind of surprises that increase commodity prices tend to also drive down stock and bond prices. “That’s why a commodity fund makes such a very good diversifier for a portfolio,” says Greer.
The other established commodities mutual fund is Oppenheimer Real Asset (QRAAX ), which is up 21% this year, after gaining 23% in 2003. It has benefited this year from an emphasis on energy, which makes up 72% of the commodities index it invests in. That heavy weighting, however, could be a drawback if oil prices fall from their recent peak, which many traders expect. “Investors chasing hot returns are quite possibly entering at the wrong time,” warns Morningstar analyst Karen Papalois in an Aug. 1 report.
What about investing in the stocks of companies that produce commodities? That’s certainly an option, and natural resources, precious metals, or energy funds all allow you to do so. If it’s energy you’re after, Morningstar recommends Vanguard Energy (VGENX ), which is up 18.8% this year after a 34% climb in 2003.
THE REAL THING. However, since these funds invest in the stocks of commodity producers, they don’t provide as much exposure to the change in the underlying commodity prices — especially since many companies hedge their own commodity-price exposure. So they may not provide the diversification from the stock market that’s a main selling point for commodity investing.
That’s one reason that Michael Cuggino, portfolio manager of the Permanent Portfolio (PRPFX ), buys the actual commodity — gold and silver coins, for example — rather than just natural-resource stocks. His fund has about one-third of its $152 million in assets in commodities as part of a portfolio designed to both “preserve purchasing power and grow,” he says.
To the uninitiated, commodity investing can seem like a whole new world. That’s why a diversified index fund can be a good place to start. It sure is a lot less risky than following your uncle into pork bellies.
Source: Business Week