It’s tempting to swap bonds for commodities these days. Commodities like copper are on the upswing, while bonds are having another tough year, down 1.2% on average, including interest.
Some research indicates you would have fared better long-term with commodities instead of bonds in a classic portfolio of 60% stocks and 40% bonds. But before you ditch bonds, consider some important caveats.
On the surface, the case for commodities looks compelling both long-term and in the current climate. According to Bank of America Securities, returns for a 60/40 portfolio of stocks and commodities beat the stock/bond version by 0.8 percentage points a year on average, going back to 1945. Commodities are “scarce, cheap and a better hedge for inflation,” said BofA in a note that included the research.
Buying commodities is a way of riding the inflation wave since they’re a key component of rising prices, making up about a third of the Consumer Price Index, according to U.S. Bank.
New technologies and a push to electrify just about everything may drive up demand for metals and energy. The adoption of electric cars has stoked interest in materials like nickel and lithium. High expectations for artificial intelligence is fueling demand for electricity and fuel sources, which means not just a rosy outlook for oil and gas, but goods used to upgrade power lines and grids—notably copper, which recently hit a record high.
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“If you really want to improve the global electricity grid you need copper,” says Rob Haworth, senior investment strategist at U.S. Bank Asset Management.
Commodities have also notched some stellar years while bonds have flopped. Consider what happened in 2022, an unusually painful year for the 60/40. The
iShares Core U.S. Aggregate Bond
exchange-traded fund declined 13%, yet the
Invesco DB Commodity Tracking ETF,
a popular basket of 13 commodities, returned nearly 20%.
Owning that commodities ETF would have gone a long way to helping returns, since the S&P 500 declined about 19% that year too.
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Still, commodities tend to be streaky, highly cyclical, and prone to boom-bust cycles. Bonds have gone through a rough patch, but they are historically far less volatile, providing some stability in a portfolio.
Timing a commodities cycle is also critical to returns. While raw materials can sometimes deliver big gains, their values are solely driven by supply and demand. And even when demand remains strong, values can sink when supply outstrips it. U.S. energy production has boomed with the shale revolution, but the same can’t be said for energy stocks: The
Energy Select Sector SPDR Fund
is up 45% cumulatively over the last decade against a 237% total return for the S&P 500.
There are also costs to investing in commodities, including fund fees and the perpetual trading costs associated with rolling over futures contracts.
Stocks and bonds promise something more: cash flows. For bonds that takes the form of interest. For stocks, it’s profits that can be translated into dividends. “You’re owning the earnings power of the company,” says
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portfolio manager Russ Koesterich, who adds most investors shouldn’t put more than 10% of their holdings into commodities.
The case for commodities may also hinges on whether you can optimize gains with other levers. BofA’s data show that over the past 80 years a 60/40 stock/commodity portfolio would have returned 10.1% a year on average, compared with 9.3% for bonds. But the analysts made assumptions that may have titled the results in commodities’ favor.
The headline results reflect returns from an “optimized” commodity index run by investment firm Auspice, which aims to boost returns and tamp down risk. A separate BofA calculation relying on a plain-vanilla, “buy-and-hold” commodity index showed slightly lower annual returns of 9.8%.
BofA also based its results on index returns, not returns of securities investors can actually buy. There is an ETF that tracks the “optimized” benchmark—the
Direxion Auspice Broad Commodity Strategy ETF.
But it charges annual fees of 0.8%, according to Morningstar, which would lower investor returns by that amount. By contrast, broad based bond ETFs typically charge less than 0.05%.
BofA also chose a bond benchmark that has been especially brutal in recent years—an index of 30-year Treasury bonds. Long duration bonds have been hit hard amid rising interest rates, posting annualized negative returns of more than 11% a year over the past three years.
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Most investors own broader portfolios of bonds that include at least some corporate bonds which are riskier but offer higher yields. Over the past decade, an investment in 30-year Treasury bonds would have returned just 0.06% a year, according to S&P data. A broad-based bond investment like
iShares Core U.S. Aggregate Bond ETF
would have returned 1.3%.
Reached on the phone Monday, study author Jared Woodard said he stood by the results. Pressed on whether the note was a provocative gambit or whether BofA would actually consider putting 40% of its clients assets in commodities, he suggested financial advisors are best equipped to choose the right mix of stocks, bonds and other assets on a case-by-case basis for individual clients.
“Our point is that commodities should be part of that mix,” he said.
Write to Ian Salisbury at ian.salisbury@barrons.com
