Should Commodities Still Be in Your Portfolio? A Post-Crisis Reckoning

Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Gregory Filbeck, Jeffrey H. Harris
ISBN: 9780190656010

Claudio Boido writes for asset managers asking a hard question in 2016: does the old commodities allocation playbook still work? Spoiler: the pitch changed, but commodities are not dead. The approach just needs to evolve.

What changed after 2008

Before the crisis, the case for commodities was clean:

• Equity-like returns
• Low correlation with stocks and bonds
• Positive correlation with inflation

Billions flowed into GSCI and DJ-UBS index products. BRIC growth fueled the commodity boom. Then everything shifted.

The average commodity risk premium fell from 5.23% (1959-2004) to 3.67% (2006-2015). Correlations with equities jumped to 0.5 during the crisis. The inflation hedge weakened because inflation itself stayed low. Erb and Harvey found the S&P GSCI returned -4.6% annually from 2004-2015 while the S&P 500 returned +7.4%.

Financialization cut both ways. More products made access easier, but also linked commodity returns to financial flows rather than pure supply and demand.

Active vs passive: the framework

Passive managers replicate a benchmark (GSCI, BCOM). They chase beta, the market exposure. Active managers hunt alpha, excess return from skill.

Grinold and Kahn’s “fundamental law of active management” says your information ratio equals skill times the square root of independent bets. You can be right often on a few trades, or mediocre on many. Most active managers choose breadth over brilliance.

The problem: alpha is a zero-sum game. More managers are underperforming. Investors are fleeing to cheap index funds.

New labels appeared: alternative beta (systematic risk in niche sectors) and smart beta (rule-based weighting by volatility, value, momentum, etc.).

How to get commodity exposure

Boido runs through the menu:

• Physical commodities - gold bars, silver coins. Low liquidity, high storage cost. Popular in crises.
• Commodity company equities - correlated to stock markets, so weaker diversification.
• Futures and options - efficient, leveraged, but roll costs matter.
• Swaps and linked notes - OTC counterparty risk.
• Mutual funds and ETFs - easiest for retail. Futures-based ETFs face rolling costs. Physical ETFs (like gold) avoid roll but have storage fees.

ETF tracking error is real. Guedj, Li, and McCann found commodity ETF returns did not always match underlying price moves.

Performance reality check

From 1970-2009, the GSCI beat the S&P 500 and EAFE on monthly returns. But energy drove that result (1.18% monthly return, 9.3% volatility). Agriculture was the laggard.

Correlations told the pre-crisis story: GSCI vs S&P 500 was just 0.034. vs bonds was negative. vs inflation was +0.318.

Post-2005, the picture flipped. Stock-commodity correlation hit 0.52. The diversification argument weakened exactly when investors needed it.

Three allocation approaches

Strategic Asset Allocation (SAA)

Set a long-term weight and hold a benchmark index. Idzorek suggested 9-23% depending on risk tolerance. But Norrish noted actual investor allocation was 0.24% of global portfolios. Facebook’s market cap exceeded total commodity investment.

SAA problems: GSCI and BCOM have structural flaws (energy overweight, ignoring correlation structure, odd inclusions like iron ore).

Tactical Asset Allocation (TAA)

Adjust commodity weight based on indicators. Technical analysis, momentum, carry signals. Works short-term on liquid contracts. Contrarian strategies fail long-term in commodities.

Factor-Based Allocation

The post-crisis upgrade. Instead of buying the whole index, tilt toward factors with evidence:

• Value - buy cheap vs 5-year average
• Momentum - ride winners up to 9 months
• Carry - favor backwardated curves
• Monetary policy - overweight commodities in restrictive rate environments

Bhardwaj and Dunsby show sectors behave differently across cycles. Grains are recession-resistant. Industrial metals rally in expansions. Energy rises with inflation surprises. Precious metals hedge inflation but not economic weakness.

Blitz and De Groot found a portfolio of momentum + carry + low-volatility premiums beat a traditional commodity index on risk-adjusted returns.

The uncomfortable conclusion

Boido does not declare commodities dead. He says the simple story is over.

You cannot buy GSCI in 2016 and expect 2000s diversification magic. Correlations rose. Risk premia fell. Index construction matters more than the marketing brochure admits.

But factor-based and tactical approaches offer a path forward. The asset class still has role-specific value. You just need to know which role you are paying for.

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