Hot Commodities in the Midst of a Cooldown

For investors who failed to heed -- or perhaps chose to ignore -- all those warnings about the volatility associated with commodity funds, February's downturn has been a pretty harsh reminder.

Since the start of the month, the two most prominent funds offering direct exposure to commodity prices have stumbled. As of Friday, the $12.2 billion Pimco Commodity Real Return Strategy fund (PCRAX) and the $1.9 billion Oppenheimer Real Asset fund (QRAAX) are down 8% and 11.5%, respectively. Prior to their fall, both funds were essentially flat year to date.

And in a rude welcome to the world of public securities, the DB Commodity Index Tracking(DBC) fund has fallen more than 9% since its Feb. 3 debut.

John Brynjolfsson, portfolio manager for the Pimco fund, attributes much of the drop in hard asset prices to the recent rumblings of Bank of Japan Governor Toshihiko Fukui and his colleagues about their plans to tighten credit.

"When the leaders behind the economy the size of Japan say that they are trying to slow growth, it's going to have a negative effect on commodities," says Brynjolfsson.

"And with less debasement of the currency, there is also less of a need to hold hard assets," Brynjolfsson adds, pointing to the yen's growing strength against the U.S. dollar as further evidence that the tumble in commodities started in the Far East.

Despite the rocky month thus far, it's hard to feel much sympathy for longtime investors in either of the open-end mutual funds. Both have averaged returns of more than 15% annually over the past three years, piggy-backing off the skyrocketing rise in energy and precious metals prices.

Newcomers just getting on the commodity fund ride, however, may be feeling a tad shaken.

"The funds are less correlated to the overall markets, which is what you want if you are looking to diversify with commodities," says Morningstar analyst Karen Dolan. "But they are very, very volatile."

To watch Gregg Greenberg's video take of this column, click here.