Two Less-Risky Ways to Invest in Commodities
Having a little bit of inflation, it's been said, is like being a little bit pregnant. It can grow and grow, and ultimately dominate your life.
Right now, we are experiencing more than a little bit of inflation. It's squeezing us at the gas pumps and horrifying us with clips of food riots in Asia.
The influx of news about the commodity boom is enough to tempt otherwise conservative investors to think about climbing aboard the "hard assets" bandwagon.
Fund investors interested in broad exposure to the commodities game are accommodated by a number of open-end mutual funds and exchange-traded funds that offer
. But these portfolios are primarily loaded with futures contracts and structured notes that tend to fluctuate more in tandem with the volatile quote levels in the wild and wooly commodity trading pits.
Typical fund investors are likely to prefer a smoother ride in their attempt to hedge against rising prices and reap some profits from the current expansion in commodities prices.
For investors interested in exposure to commodities, but in search of a less wild ride than funds and ETFs loaded with futures contracts and commodity derivative instruments, two possibilities are summarized in the accompanying table.
The
Direxion Commodity Bull 2X Fund
(DXCLX)
and the
RS Global Natural Resources Fund
(RSNRX) - Get Report
invest in stocks of commodity-related corporations, rather than hyper-volatile futures instruments and derivatives.
A warning, however, is that that the Direxion fund, as the "2X" in its name suggests, although linked to stocks, is leveraged to produce returns at roughly twice the amplitude of movements in the underlying securities. Its gearing is achieved through the use of equity swap contracts in the Morgan Stanley Commodity Related Equity Index. The index, however, is one of commodity-related corporate stocks and not futures, derivatives or hard assets.
Whereas many funds focus on a single area of commodity-related investments, such as petroleum producers or precious metals miners, the portfolios of the Direxion and RS funds cover broad ranges of hard assets, including various metals, energy sources, chemicals and, in the case of Direxion, food and forest products.
In addition, for those who believe that money is the ultimate commodity, both the funds have international holdings that have benefitted from the strengthening trend of foreign currencies vis-a-vis the U.S. dollar.
Both the funds have easily outdistanced the
S&P 500
total-return index over the most recent 12 months, as well as the past three years. Over the 12 months ended March 31, the leveraged Direxion fund surpassed the impressive return of the broad-based S&P Goldman Sachs Commodity Index by a hefty margin of more than 17 percentage points.
But over the same period, the subdued performance tendency of stocks vs. futures held the return of the RS fund to 15 percentage points lower than the GSCI gauge.
For the first quarter of 2008, the stocks in the Direxion portfolio placed the fund's performance within a single basis point of the negative 9.45% suffered by the S&P 500. At the same time, the relative strength of its commodity-related investments held the RS fund to only a modest setback of 1.21%. By comparison, the commodity boom lifted the S&P MSCI benchmark by 9.92% for the quarter.
In addition to their hoped-for ability to insulate their owners from the impact of inflation, funds that focus on commodity-related stocks will almost certainly suffer less volatility than futures-based or derivative-linked portfolios.
Investors should be aware that a risk in owning commodities-related stocks is that companies in the business of processing commodities and selling the output can suffer profit squeezes that result from elevated raw-material prices on the acquisition side and lids on their final prices caused by buyer resistance on the sales side.
A big concern when considering commodity investments is where we are in the boom-bust price cycle. With the economy weakening and consumers starting to finally pull back, will commodity prices keep heading for the stratosphere?
Richard Widows is a senior financial analyst for TheStreet.com Ratings.