Earlier, we highlighted three reasons to own commodity stocks, not commodities themselves. The thesis stemmed from research done by Jeremy Grantham (Trades, Portfolio) and Lucas White of GMO LLC, an asset manager with more than $120 billion in assets.
It is worth your time to listen to Grantham. He's credited with calling the 2008-2009 housing collapse and the following credit crisis. Previously, he started one of the world's first index funds in the early 1970s, avoided investing in Japanese equities and real estate in the 1980s and recommended not investing in technology stocks during the Internet bubble in the 1990s.
As with previous market calls, his suggestion to buy commodity-linked equities rather than commodities themselves is backed up with historical precedent. Apart from his three straightforward reasons for doing this, here are three of his more nuanced arguments.
1. Both protect from inflation
A major argument for investing in commodities is that they show strength in times of rising inflation. So do commodity stocks, however.
Inflation in the U.S. has reached 5% or higher in eight fiscal years in the last century. As a whole, energy and metals companies beat inflation a majority of the time. On every occasion, commodity producers outperformed the Standard & Poor's 500.
2. Buy at a discount
Since the 1920s, commodity producers have traded at average 20% discount to the S&P 500. According to Grantham, "Rather than focusing on the benefits of resource equities, investors are understandably uncomfortable with the wild, unpredictable swings of the industry, driven by over/underinvestment cycles, supply disruptions and unexpected changes in demand among other factors."
3. Buying at a discount means bigger long-term returns
According to Grantham, "The ability to buy commodity producers at a discount due to their short-term riskiness may be yet another attractive feature of resource equity investing." Over 10-year periods, the real returns for resource equities have not only been fairly stable but also have beaten the S&P 500 a majority of the time.
Even with horrific returns over the last few years, energy and metals companies have handily outperformed the S&P 500 by a sizable 2.2% since the 1920s. Today, valuations continue to hover around all-time lows, putting resource equities in the cheapest quintile of history relative to the broad market.
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