Jeremy Grantham Says Own Commodity Stocks, Not Commodities

Jeremy Grantham and Lucas White lay out a compelling case

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Sep 09, 2016
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In recent years, it has become vogue to invest directly in commodities, especially with the advent of ETFs allowing quick, cheap and easy exposure. Given the performance gap between, say, gold miners and the price of gold, many investors have been satisfied with their decision.

But, in a recent white paper, Lucas White and Jeremy Grantham (Trades, Portfolio) present a compelling case for investing in resource equities rather than the commodities themselves. Here is what they found.

1. Over the long-term, investing in companies over commodities is a winning strategy.

While oil prices have barely risen in real terms since the 1920s, oil and gas companies have generated real returns of more than 8% per year. A similar trend can be seen with industrial metals companies.

According to Jeremy Grantham (Trades, Portfolio), "The public equity market has clearly been far superior to direct commodity investment historically, and that is not even taking into account the storage and transportation costs, perishability issues, etc., associated with direct commodity investment."

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2. Investing in commodity ETFs has major performance disadvantages.

A well-known issue with ETFs is the futures "roll yield" dillema. Most resources ETFs do not actually own the underlying commodity given the expense in doing so. Instead, they buy futures and simply "roll" these contracts over before they expire.

When they sell out of an expiring contract and roll into a longer-dated contract, there is almost always both frictional costs and tracking error. Over decades, this can reduce your returns significantly.

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3. Long-term investors still get their diversification with companies over commodities.

One of the biggest pitches for investing directly in commodities comes from the diversification angle, where there is plenty of data showing that resources have been negatively correlated with the price of equities for decades. Investing directly in commodity-exposed companies, however, provides a very similair benefit if you invest for the long-term.

Over any period one year or longer, energy and metals companies have significantly more diversification benefits than traditionally "counter-cyclical" sectors like consumer staples or utilities.

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Investing with a long-term framework has proven to be both a winning and lower-risk strategy. Over rolling ten-year periods, energy and metals companies have nearly doubled the market's average return (even when including the recent downturn!) while showing lower volatility.

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Disclosure: I have no positions in any of the stocks mentioned above and no intention to initiate a position in the next 72 hours.

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