In a recent article entitled Is Gold really a good Inflation Hedge? I showed the history of Gold and how it really was a fear hedge rather than an inflation hedge.
Interestingly, I just read an article entitled “Wanna Beat inflation? Forget Commodities!” by newsletter author Dan Ferris.
It seems almost like heresy to hear that statement from Dan since he writes commodity and oil-based newsletters. But some of the statistics he presented were very interesting so I thought I would pass them along to you.
Dan says, since 1921 gold has only risen about 1.5% per year. Silver has risen less than 1/2% per year since 1792 and copper which recently made its way back up to $3.50 per pound actually traded at $4.50 way back in 1855.
Dan’s premise for the article is that over the long haul stocks have done much better yielding about 9.5% when you include dividends.
I would agree with Dan that holding commodities long term are losing investments! But what Dan failed to mention was that during various periods commodities have far surpassed stocks. So just like anything you have to be holding the right asset class at the right time.
Performance by Asset Class
|Foreign Stocks, Large & Small Cap U.S. Stocks
|Art, Commodities & Gold
|Real Estate, Small Cap stocks, Bonds, Gold, Oil.
|Large Cap Stocks
As we can see from the table above stocks were not always the best performers and during the 1970’s–Gold was the clear winner. Over the last three years, oil and gold have been big winners creating hundreds of percent returns.
So when conditions are right, commodities not only keep up, they can actually shine. So, blanket statements about commodities not beating inflation are simply not true. The correct answer is that sometimes they do beat inflation (in spectacular fashion). So the key is to be in the right asset class during the right decade.
One approach to doing that is called asset allocation. The basic theory behind asset allocation is that you would allocate your funds among all the asset classes so that even though some go down others would go up enough to make up for it. “Modern Portfolio theory” is based on this.
The way it works is that you might own five different asset classes, ensuring that they are not correlated. In other words they all move independently.
Perhaps you might have:
- Large Cap Stocks
- Small Cap Stocks
- International Stocks
This could be further diversified to include Real Estate, Art, Coins, and you could divide the international stocks into regions like Europe, Asia and South America.
To keep the example simple we will start by working with only two asset classes.
We could start with Large Cap Stocks and Commodities. For simplicity lets assume that they have a negative correlation meaning that when one goes up the other goes down.
What might happen?
Year 1- Stocks double, Commodities go in half.
At first you might think you are back to being even but you actually aren’t. Since Stocks doubled commodities could have gone to zero and you would have been even but since they went to half you actually end up being up by 50%.
So assuming you started with $1000 in stocks and $1000 in Commodities at the end of year 1 you would have $2000 in stocks and $500 in commodities for a total of $2500 (up from $2000 to start).
At this point, “Modern Portfolio Theory” would have you re-allocate putting money into commodities from the stocks, so they would be even again. This is the difficult part, why would you want to sell your winners and buy more losers? but it is a necessary component of “Modern Portfolio theory”.
The advantage is that it forces you to sell over priced assets and buy under priced assets. And if you spread it over several different asset classes in the long run it has proven to increase your total returns.
The point is that you need to be in the right asset class during the right decade and it is a historical fact that there has never been an instance where the best-performing asset class during one decade was the leader during the next decade. So the safest route to beating inflation is asset allocation.
As we saw in our example even though one component of our allocation went to half its value our overall portfolio increased by 25%.
By spreading over even more asset classes we are able to decrease our overall portfolio volatility even further and increase our overall performance.
In addition to Fear… Chinese demand may be driving up the price of Gold. See: Why (and How) China is Boosting the Price of Gold for more information.