Gold vs. Ag: Quest for the Best Hedge

Let's take another look at whether agricultural commodities, as measured by PowerShares DB Agriculture Fund(DBA Quote) could be a better stock-market hedge than gold, StreetTRACKS Gold Trust(GLD Quote).

What's different now? The S&P 500 has entered a bear market, and commodities of all sorts have skyrocketed (but, of course, have corrected aggressively in the last couple of weeks).

From the date of that article -- August -- GLD outperformed for a while; then, DBA was the better performer. The net result was a tie.

In that time, DBA has had a slightly lower correlation, 0.098, to SPX than GLD, 0.183. The fact is, either one would have been a great hold as stocks were rolling over.

As awareness of commodities has grown and new products have made them accessible in brokerage accounts, a mania of some sort has ensued. There was plenty of commentary and sentiment urging more commodity exposure. This makes some sense, as there is a compelling case that demand for commodities has been increasing, while stocks have been faltering.

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I would encourage investors to maintain a moderate weighting to commodities perpetually for its diversification benefits.

For investors looking to hedge an equity portfolio, 2%-3% in GLD, DBA or both would be sufficient without causing real anguish from a big commodity correction.

Given that commodities are new to many investors, especially with the longer market cycles than stocks usually have, there's an extra layer of complexity to the portfolio. I think that's all the more reason for moderate exposure for most people.

Moderation is the key concept.

Equities go up the vast majority of the time, while commodities have more of a mixed track record; remember that from its high in the early 1980s, gold is barely up 10%, while the S&P 500 is up 12-fold.

Even if the difference is less over the next 25-30 years, betting on commodities at the exclusion of equities is very likely a losing proposition. I say this as someone who does believe that some exposure is very important and that the demand for resources is very likely changing for the better.

According to PortfolioScience.com, the standard deviation of the S&P 500 SPDR(SPY Quote) has been 19.95 since I wrote that article in August, while GLD has had a standard deviation of 19.97 and DBA had 25.64.

So, the correlation has been low, but the volatility has been about the same.

In addition to some changes in fundamentals that have helped commodities, the increased number of commodity ETFs has become a destination for some of the money coming out of stocks. It stands to reason that when stocks finally do bottom, there will be capital that flows out of commodity ETFs and into equities.

Perhaps this week is a microcosm for that effect.

Commodities are merely a segment of the capital market that offers a chance to speculate on a particular outcome or hedge an equity portfolio. As a hedge, I believe they have proven themselves as a great tool to help smooth out the ride in a bear market; as a means to speculate, I don't think they are any different from anything else.

They had a great run, will very possibly continue that great run and also have nasty corrections along the way -- no different from other asset classes.