For years I was convinced I had no place making any bets that depended on the direction of commodity prices or currencies. After actually sitting down and doing a lot of reading my approach has changed with respect at least to oil prices.
Here is an article that tackles the subject of an investor trying to capture movements in the price of commodities:
"But at first glance, it looks like many of today’s most successful investors are paying no attention to Graham and Simon’s advice. For example, one of the world’s most consistently successful and widely emulated asset managers, Yale University’s David Swensen, has more than a quarter of his portfolio in companies and properties that grow, harvest, drill and otherwise exploit natural resources.
Swensen has been running Yale’s endowment since 1985. Over the last 20 years his fund, worth US$16.7 billion, has delivered returns of 13.1% per annum, far outpacing equity and bond markets, as well as most of his peers. His approach, known as the Yale Model, has become the template for large asset managers with long time horizons. The traditional endowment or pension fund is a mix of bonds and equities — once upon a time almost exclusively bonds, and these days more often a 60/40 equity/bond split. Swensen completely rethought that approach, investing overwhelmingly in assets other than bonds, with a preference for inefficient markets where smart, active management may be able to earn outsized returns. At the start of 2011, 28% of the Yale portfolio was allocated to what Swensen calls “real assets.” Swensen’s three core real assets are real estate, oil and gas, and timber.
And yet despite investing billions in what appear to be commodities, Yale’s guru agrees with Graham that simply hoarding “things” offers poor returns. As Swensen explains in his book describing the Yale Model, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment, “pure commodity price exposure holds little interest to sensible investors, as long-term returns approximately equal inflation rates.” In other words, if you think that buying and holding a physical commodity such as gold will give you a hedge against inflation, well, you’re right. But merely keeping pace with inflation isn’t the goal of investing, growth is.
According to Swensen, in the 80 years between 1925 and Dec. 31, 2005, U.S. inflation rose 16-fold. The returns on risk-free, short-term U.S. T-bills performed as expected, only slightly outpacing prices and delivering an 18-fold return. Buying and holding 20-year U.S. government bonds increased your money 71-fold. Corporate bonds delivered 100-fold returns. U.S. common stocks, in contrast, grew your investment 2,658-fold. And gold? It was up only 27-fold.
If even gold, the king of commodities, offers sub-par returns, why does the Yale model rely so heavily on what seem like commodity plays. The rub is that Swensen isn’t hoarding barrels of oil or buying oil futures, but investing in working businesses in the commodity space. The distinction is everything. “Oil and gas reserve purchases and timber investments provide investors with commodity price exposure and an intrinsic rate of return,” explains Swensen, “thereby dominating price exposure alone.” English translation: The only way you make money from owning a barrel of oil or investing in oil futures is if the price of oil goes up quickly. That’s a short-term trading strategy, and enormous fortunes have been made trading commodities. But it is not, in Swensen’s view, a long-term investing strategy. In the long run, buying physical commodities holds as little interest for Swensen as it did for Graham.
Shareholders of, say, Exxon Mobil or Encana receive inflation protection thanks to the companies’ ownership of commodities — that’s Swensen’s “price exposure.” They also get a return through retained earnings and dividends generated by the exploitation of the company’s oil and gas reserves, and the discovery and acquisition of new resources — that’s Swensen’s “intrinsic rate of return.”
For the entire article:
http://www.financialpost.com/m/blog.html?b=business.financialpost.com/2011/05/04/wild-things&s=Opinion
