I am not a lover of commodities as investments, but they can be good when trying to find the best trade in the market. The stock market is very different from the commodities market and the difference is so fundamental to investing that if you don’t understand it, you may never succeed in the stock market.
If you look at every 10-, 20-, 30- and 35-year rolling period of the stock market, you will notice that the market has always gone higher. With the exception of one 10-year period that included the Great Depression, the trajectory of the stock market over time is always up.
Not only that, the longer the time frame, the more returns increase.
That’s why I tell you to hold a long-term diversified portfolio.
Commodities, however, are entirely tied to both economic cycles, and to changes in supply and demand within each commodity market itself. Thus, if you were to overlay all the long-term commodity charts on each other, you would see what looks like a kindergartner’s scribble. Up and down and up and down and up and down. There’s no real pattern.
Here’s a 10-year chart for lean hogs. Track it with … a petting zoo.
You get the idea. That’s why, when I say “diversified”, I deliberately exclude commodities (including precious metals) from that word.
How to Zero In On the Best Trades
Now, there are commodity traders who have figured out the best trade in the market. I have a lot of respect for them because they are either insane gamblers or they understand those markets so well that they can figure out when to enter and exit their trades.
However, because of the way the economic cycles work, there is a time when you can make the best trade on commodities. Take a look at the PowerShares DB Commodity Index Tracking Fund (DBC). This is a basket of commodities: Aluminum, brent crude, copper, corn, gold, heating oil, light crude, natural gas, RBOB gasoline, silver, soybeans, sugar, wheat and zinc.
Notice how over the past ten years, the DBC peaked around $40 before the financial crisis, and has since crashed to $14.91, just off a low of $12.75. That tells me that you could consider a trade here, with downside of about 15% (although it could be more), and possible upside to $30, or 100%.
However, this ETF has five elements that are tied to energy, and while this is probably a decent way to play on energy price rebounds that is somewhat diversified, we can look to other ETFs for more diverse commodity elements.
The WisdomTree Continuous Commodity Index Fund (GCC) owns multiple contracts across a more diverse set of commodities: West Texas Intermediate Crude, NY Harbor Crude, soybeans, corn, soybean oil, wheat, copper, live cattle, lean hogs, natural gas, gold, platinum, silver, cocoa, cotton, coffee and sugar.
If you compare the charts of DBC and GCC, you’ll see that since January of 2008 (when GCC began) GCC did not experience the same losses as DBC and outperformed it on the upside. By late April of 2011, DBC had fallen 40% during the financial crisis compared to about 32% for DBC. However, in the subsequent recovery, DBC barely got back to break-even while GCC was up 17%.
Since that top, again with the January 2008 date for inception, DBC is off 54% and GCC is off 34%. That’s the power of diversification.
So I would say GCC is the best trade at this level. There could be more downside, but opening a small position at about $20 and looking for an $8-$10 return is a better play.
As of this writing, Lawrence Meyers did not own shares in any security mentioned.