Are we talking about stocks or bonds? Neither, we are talking about commodities. Investors usually think about stocks and bonds as the only two investment choices for their portfolio. This type of thinking causes investors to miss out on other investment opportunities (like Business Development Corporations which we discussed back in 2015) that can enhance returns while reducing risk. With Central Banks around the world keeping the printing presses going, most of that cash has gone into financial instruments (stocks and bonds) and real estate. Headline inflation has remained low because commodity prices have declined. Is that changing?
Below is a chart that shows the relative returns of commodities compared to stocks. Currently, commodities are at their lowest valuation relative to stocks since 1970. The last two times we were down to these levels were the “Dot.com Bubble” in 1999 and the “Nifty Fifty” stock craze in the early 1970’s. Both periods proved to be a bad time to own those stocks and a good time to own commodities. With the divergence being at its greatest level in more than 40 years, commodities, in our opinion, should outperform US large company stocks over the next several years.
What does this mean for your portfolio?
We follow a disciplined investment approach that looks at valuation and reversion to the mean. This means we look to buy undervalued assets where prices will “revert back” to normal. Because commodities are extremely cheap when compared to US large company stocks, we have a good portion of our client assets allocated to this asset class. We have done this through commodity-oriented investments like energy, gold mining and managed futures. Managed futures are investments in the futures market that include currencies, interest rates, equities and commodities. Until recently, investing in managed futures was only available to large institutions or wealthy individuals. Individual investors are now able to invest in mutual funds dedicated to managed futures. As the strategies of these funds vary greatly, one needs to be careful when selecting a managed futures fund. The managed futures fund we use is managed by one of the original “Turtle Traders” with a long history of investment success by following a disciplined process.
The last two charts below show the benefits of having managed futures as a part of your portfolio. The first chart shows that managed futures have generated a higher return than stocks since 1980. During times of crises, managed futures have actually made money while stocks fell in value. The next chart shows the maximum drawdown rates from 1990 to 2012. The managed futures maximum drawdown (difference between high and low prices) is just over 10% compared to much more significant drawdowns in stocks. At the end of 2008, it was a great time to invest in stocks rather than commodities. Today, we believe the opposite is true.