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Commodity Funds Soar, But Can It Last?

Richard Widows

After all, returns on many commodity funds were smartly higher during a period when stock price indices were suffering near-double-digit setbacks.

TheStreet.com Ratings produced the two accompany tables by filtering our databases for open-end mutual funds, exchange traded funds and closed-end funds for those with names or descriptions that identified them as having investment objectives based on commodities.

Some fund classifications, such as precious metals and energy/natural resources, are by definition related to commodities. In these categories, the funds that specifically aim to achieve gains with futures market instruments or specifically track a physical commodity rather than stocks of firms involved in its extraction, production and fabrication or production are listed in the table.

Each of the seven commodity-related open-end mutual funds in the shorter table moved higher during the difficult three months ended Feb. 29. Five of the funds scored double-digit advances during the period, with the group achieving an average a gain of 17.03% during a period when the S&P sank 9.68%.

Characteristically for this relatively new mode of investment, there are a lot of options: 17 exchange traded funds were found to focus on commodities.

To stress their pioneering nature even further, most are technically not ETFs but a new subcategory known as ETNs, or exchange trade notes. They are similar to ETFs, except that their respective values are keyed to notes rather than to "baskets" of securities.

Of 13 ETFs/ETNs with three-month price-history data, all but one was ahead for the period, with the average "commodity" ETF/ETN returning 19.34% for the three months.

Whereas the seven open-end commodity-related funds are broad-based in their objectives, many on the ETF list focus on specific segments such as agriculture, livestock, energy or metals. Some are even narrower in scope, confining their investments to specific areas such as copper, nickel or natural gas.

The single commodities-focused closed-end fund -- found at the bottom of the same table as the ETFs -- is broad-based in its investments.

With most international stock bourses -- and even many fixed-income investments -- moving roughly in tandem with the U.S. stock market, true hedges that move independently of the U.S. security prices are difficult to find. Because they tend not to correlate to any high degree with other investments, commodities can provide true portfolio diversification.

Moreover, when commodity prices rise, boosting the values of funds that hold them, the higher raw materials costs tend to squeeze corporate profits and depress prices of common stocks. So it isn't unusual for commodities to gain during periods of stock market weakness.

But commodity-induced inflation, as is being experienced worldwide at present, also prompts central banks to take measures to bring prices back into line. An investment in rising commodities could end up being fought by no less than the U.S. Federal Reserve, the European Central Bank, the People's Bank of China and other monetary crusaders for price stability.

In addition, rising prices motivates providers to find ways of boosting supply and thereby reverse inflationary trends. Herds are increased, new land is cultivated, exploration for minerals is intensified and, given time, supplies are brought to market in quantities than can unexpectedly reverse price trends.

Before jumping aboard the increasingly fashionable commodities bandwagon, it might be worth recalling a famous wager made in this arena.

At the end of the inflationary 1970s, when many pundits were forecasting even greater price increase in the coming decade, economist Julian L. Simon made what has thereafter been known simply as "The Bet" with neo-Malthusian author Paul Ehrlich. They wagered the grand sum of $1,000 that Ehrlich couldn't name five commodities that would rise in price over the 10-year period beginning Sept. 29, 1980.

Ehrlich picked five industrial metals, not one of which was priced higher on that same date in 1990.