If there’s one asset most investors don’t own it’s probably commodities. And with consumers feeling the pinch of higher inflation, these assets are starting to get more attention. Before we examine strategies for incorporating commodities into a diversified portfolio, let’s lay the groundwork for investing in them.
They are broadly defined as the raw inputs for products. For example, palm oil is the base ingredient for many products like biodiesel, lipstick, detergent, soap and even ice cream. These items can be subdivided into categories such as agriculture, energy, and metals.
Broad Exposure
Exchange-traded products offering convenient exposure to a diversified basket of commodities abound. One example is the iShares S&P GSCI Commodity-Indexed Trust (GSG). It currently has the bulk of its exposure (60.34%) in energy commodities like crude oil. The rest of the vehicle holds agriculture (17.20%), industrial metals (12.23%), livestock (5.76%) and precious metals (4.47%).
For investors who want simplified tax reporting, the USCF SummerHaven Dynamic Commodity Strategy No K-1 Fund (SDCI) allows investors to avoid the hassle of reporting on the Schedule K-1 tax forms, which are often otherwise required for commodity investments that act as partnerships.
The fund is composed of 14 commodity futures contracts, weighted equally and selected each month from a universe of 27 eligible commodities futures contracts. SDCI covers key commodity sectors like petroleum, precious metals, industrial metals and grains.
Strategic Exposure
Aside from weather and politics, commodity prices are heavily influenced by business cycles. For instance, the ongoing shift toward alternative energy and transportation is lifting demand for industrial metals like aluminum, copper and lithium. This is a longer-term cycle, however, as the nations across the globe move to reduce their carbon footprint. The electrification of automobiles is a case in point.
"The average electric vehicle requires about 183 pounds of copper versus just about 20 pounds for a gas-powered vehicle," said Stan Kiang, director of exchange-traded funds at Aberdeen Standard Investments. Aside from copper, he notes a similar demand in the fast-growing solar energy marketplace. “About 85% of solar components require aluminum,” Kiang said.
Single commodity ETFs like the Global X Lithium & Battery Tech ETF (LIT) and the U.S. Copper Index Fund (CPER) have been strong performers this year. LIT is ahead by 42.44% while CPER has jumped by 28.20%. And as the demand for industrial metals increases with the major shifts in business, more gains could be ahead.
Equity Exposure
Investing in industry sectors closely tied to commodities is another approach for getting market exposure to the group.
The Fidelity MSCI Materials Index ETF (FMAT) contains companies involved in specialty chemicals, industrial gases, paper packaging, steel and mining. The fund has 117 holdings, and the top ones include Linde PLC, Sherwin-Williams and Freeport-McMoran.
The Energy Select Sector SPDR ETF (XLE) carves out the energy stocks within the S&P 500. The fund holds 21 stocks across the oil and gas subsector. XLE has jumped 56.53% year to date, making it the top performing S&P 500 industry fund thus far this year.
Summary
Commodities are a major asset class that is underrepresented in most investment portfolios. ETFs offer an easy solution to add more diversification while allowing advisors complete flexibility.