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Taking a Fresh Look at Equity Commodity Funds

The old guard may offer some overlooked attributes.

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Investors' interest in commodities has exploded over the past 10 years. Whether they're looking for diversification, an inflation hedge, or to speculate on rising prices, investors have plowed hundreds of billions of dollars into commodity-related offerings, both mutual funds and exchange-traded funds. A decade ago, commodity-related funds (at that time, only the open-end equity energy, precious metals, and natural resources categories existed) held just $10 billion in assets. Today, after gold has soared to $1,650 an ounce from $300 and oil has gone from less than $30 per barrel to north of $100, total assets in ETFs and open-end commodity-related funds hit an astonishing $320 billion in February.

Yet, it remains debatable whether the average investor even needs dedicated commodity exposure. Most equity investors already get a fair amount of commodity exposure through energy and materials equities. Those two sectors claim a combined 15.6% of the S&P 500 Index. The counter argument is that a small commodities weighting offers diversification benefits, but rising correlations in recent years potentially diminish those benefits. Neither do commodities always provide a perfect hedge against inflation or a falling dollar. That was the case for oil versus a weak dollar in the 1980s and gold versus inflation from the mid-1930s through the 1960s. (Not coincidentally, though, gold prices have soared since the U.S. went completely off the gold standard in 1971.) More broadly, we are currently 13 years into a commodity bull market. Despite calls that this time it's different and that resources will be permanently constrained, similar things were said during the last commodity boom in the 1970s and early 1980s. Human ingenuity has confounded such predictions in the past and there's always the potential for prices to revert to the mean.

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Kevin McDevitt has a position in the following securities mentioned above: GLD. Find out about Morningstar’s editorial policies.