Prices of commodities have been soaring and many investors in managed futures have exceedingly benefited. Recent cotton prices were higher than they had been since the Civil War. Lumber prices are moving higher as the Chinese are buying North American lumber and a beetle is destroying large sections of Canada’s timberlands. Prices in soybean, wheat and corn have risen approximately 45 percent, 50 percent and 65 percent, respectively, since July 2010’s lows. The record-setting U.S. grain crops that were originally projected never happened, and there have been crop shortages worldwide. Silver is up more than 60 percent year to date, even outstripping gold’s gain of 24 percent over the same period. And the list of gainers extends to many other commodities. (All percentage gains are as of Nov. 10, 2010.)
Maybe you are thinking that the commodity bubble will burst. Well, many ( but not all) bull markets have seen meaningful correction(s) and many have then continued an upward advance. Why not stay within the investment confines of the U.S. equity and debt markets? U.S. equities have generated a negative return for most investors over the past ten years.
The U.S. will most certainly remain challenged for many years to come. The U.S. is debt burdened: its federal and municipal governments continue to borrow while its citizenry is attempting to deleverage. Further, the U.S. has an aging population, which will require all sorts of financial support in retirement years. And, lastly, the Federal Reserve, in efforts many consider questionable, has reopened the printing presses; the U.S. dollar is offered in sacrifice. And the dollar is not alone in its race to devalue; the buying power of all major currencies (the yen, the Euro, the U.S. dollar, the British pound) have depreciated nearly 80 percent relative to the value of gold. On the other hand, commodities have fared very well since 2003, way out performing equities and bonds. I believe that the simple investment premise behind the recent rise in commodities may well remain true for the next decade. The U.S. has slow growth but China, India and Brazil have IMF projected GDP growth rates for 2010 of 10.5 percent, 9.7 percent, and 7.5 percent, respectively, and hefty future growth. These countries are large, profitable manufacturers and exporters. They also have a growing middle class made up of people who want to improve their standard of living.
These billions of individuals now want cars, trucks, appliances and homes. The manufacture of such requires a lot of basic materials: metals, lumber and huge amounts of energy and water. Once made, the usage of the products requires even more energy consumption.
This new middle class wants better food for themselves and their children; they want to eat more protein. The production of protein from grain-fed animals requires eight times as much fossil fuel energy as the production of plant protein (Environmental Health Perspectives, 2010). Foreign Central Banks are impacting precious metals prices; many countries are clamoring for a return to a gold standard or to tie currencies to a basket of several commodities, including gold. The concept that commodity investing is risky is quite true. But the index of managed futures programs ( as presented by the CME Group in their studies) has demonstrated less risk in the form of less volatility of returns and smaller draw downs. Many managed futures traders embrace and employ strict trading rules, as approximately 75% of managed futures programs are systematic (or computer generated trades).
Buy and hold equity investing largely ignores loss minimization rules; as such, managed futures can be described as about half as risky. Managed futures have the added benefit of being uncorrelated to the U.S. equity and bond markets. The 1983 seminal study of Dr. John Lintner, a Harvard professor, titled “The Potential Role of Managed Commodity-Financial Futures Accounts in Portfolios of Stocks and Bonds” was recently updated and confirmed by the CME Group (which includes the CME, CBOT, NYMEX and COMEX). Dr. Lintner found that inclusion of managed futures in portfolios decreased risk: “... the combined portfolios of stocks (or stocks and bonds) after including judicious investments in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.” Per the CME, “Managed futures have been one of the very few bright spots for investments (both alternative and traditional) during this recent crisis in the economy,” as they survived and actually profited during the financial meltdown of 2008.
“The main benefit of adding managed futures to a balanced portfolio is the potential to decrease portfolio volatility. Risk reduction is possible because managed futures can trade across a wide range of global markets that have virtually no long-term correlation to most traditional asset classes.” And possibly the strongest statement by the CME is: “The results are so compelling that the board of any institution, along with the portfolio manager, should be forced to articulate in writing their justification in not having a substantial allocation to the liquid alpha space of managed futures.” Now, if inclusion of managed futures is considered essential for institutionally managed portfolios, would it not also be essential for portfolios of individuals? It is important to talk to advisors about your portfolio. As most advisors do not have expertise in commodities and can’t sell or manage commodities, you might be well advised to find a commodities professional and discuss inclusion of managed futures in your portfolio.
— Jeannette Rohn Showalter is a Southwest
Florida-based chartered financial analyst, considered to be the highest designation f or investment professionals. Her office is at The Crexent Business Center, Bonita Springs. She can be reached at 444-5633, ext. 1092
An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
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