Commodities like gold have been recommended as a great investment for years. Adding to our portfolio consisting of stocks and bonds another type of investment – commodities, is theoretically supposed to reduce overall risk and keep the expected return same, or push it slightly higher.
What is the better way to find out if we should add commodities to our portfolio than to look at their returns and compare it to bonds and stocks?
The period covered is 10 years, ending 31/12/2016.
Return of stocks (measured by S&P500), bonds (measured by S&P Bond Index), and finally commodities (measured by S&P GSCI) for the past ten years can be seen on the chart below.
Even though stocks are generally said to reach the highest returns, as we can see, it does not have to be true all the time. The returns we would get are 69,92%, 57,85% and -8,17% for bonds, stocks and commodities respectively. That means that by investing into bonds we would get an average annual return 77 basis points higher than by investing into stocks. This is caused by financial crises that occurred at the beginning of period, which sent the stocks rapidly down but they were catching up with bonds quickly.
The exactly opposite can be said about commodities, which did not prove to be a right investment. Fall of the commodities index is partly caused by oil prices which decreased rapidly, as oil is a significant part of the index and the same is true for gold, which decreased in value as well.
Now let´s look at the volatility of the assets. This was measured by the coefficient of variation, which is defined as the ratio of the standard deviation to the mean. This may not be the best measurement of volatility but we consider it to be enough for basic explanation and visualization of how the prices fluctuated during each of the years.
From these three groups of assets, it can be seen that commodities experienced the biggest volatility during the period. As they ended up in negative return field after 10 years, we could conclude that commodities may not be the best investment for long term, but their volatility can be used for short term speculations and profits (or losses).
Interestingly, asset with the lowest volatility, bonds, reached the highest returns (assuming the volatility as a measurement of risk).
Even though broad commodity index may not be very attractive, there are commodities which outperformed the index and therefore would be worth an investment, and these will be the topic of our next article.