Just how well can commodities improve your portfolio's risk-return profile? We run the numbers using various commodity ETF allocations.
There's nothing like a bracing splash of reality to put things in the proper perspective.
Last week, we examined the efficacy of various hard asset exposures—gold, oil and broad-based commodities—on portfolio performance (see "How Good Is YOUR Hard Asset Investment?") and found that gold did the best job of boosting yields and lowering risk over the past year. On paper, that is.
You'll remember that when we took a 10 percent bullion allocation out of the fixed-income side of a stock-and-bond portfolio, we enhanced our returns 2.2 percent with only a 0.3 percent uptick in risk. But that was the view from 10,000 feet. The picture's quite different from the ground.
First of all, because the example assumed constant—i.e., daily—rebalancing of the portfolio. That's unrealistic for most investors. To maintain a constant 10 percent allocation, bullion would have to be sold on days when the metal's price advanced more than the stock and/or bond allocations. That's both impractical and expensive.
Rebalancing is costly, both in terms of hard transaction charges and bid/ask spreads. You pay the freight for rebalancing in yield—at some point, frequent rebalancing stops paying for itself.
The other consideration is liquidity—the ability to transact immediately. Daily bullion dealing just isn't practical for most investors. However, dealing in bullion proxies, such as exchange-traded gold trusts, is.
So, let's turn our attention to a real-world portfolio—one with a more manageable rebalancing schedule and that uses investment vehicles available to John or Jane Q. Public. Let's rejigger our portfolio allocations monthly, instead of daily. And let's use exchange-traded trusts, funds or notes to obtain our exposures.
The Many Faces Of Gold
In the real world, investors can obtain exposure to the gold market through bullion itself or through gold mining stocks. A bullion-based investment is "purer" in the sense that it's just gold. Mining shares are, after all, stocks. As such, they provide exposure to both gold's price and the stock market.
There's more than one kind of gold miner, too. Some gold producers are in the business of cranking out actual bullion from their operations—that is, they produce revenue—while other junior shares explore and develop prospective gold fields. Junior mining shares are more speculative and—no surprise here—more volatile.
We'll use the SPDR Gold Shares Trust (NYSE Arca: GLD) as our proxy for bullion, the Market Vectors Gold Miners ETF (NYSE Arca: GDX) to stand in for gold producers and the Market Vectors Junior Gold Miners ETF (NYSE GDXJ) to represent E&D outfits.
We'll also employ a monthly rebalancing schedule to maintain our target allocations. The base for our portfolio—as before—is a 60/40 mix of stocks and bonds. We'll keep 60 percent of our capital in broad-based large-cap domestic stocks through SPDR Depository Receipts (NYSE Arca: SPY). We'll carve our hard asset exposure from our 40 percent bond allocation, as represented by the iShares Barclays Capital Aggregate Bond Index ETF (NYSE Arca: AGG).