MW: Commodities don't diversify stock-market risk as much as believed
By Sam Mamudi, MarketWatch
NEW YORK (MarketWatch) -- As stocks retreated and recovered over the past 15 months, commodities investments have moved in step with the U.S. market.
That wasn't supposed to happen. Investing in commodities has been pushed as a useful way to cushion portfolio risk. In truth, the performance of commodities and stocks is now closely related, shredding the promise of diversification and strapping investors to the market's wild rollercoaster.
"We haven't seen the independence [in commodities returns] that you'd hope for in a diversified portfolio," said Jay Feuerstein, chief executive of Chicago-based commodity trading adviser 2100 Xenon Group.
Commodities such as oil, corn, copper and grain crumbled as the market tanked and have climbed this year along with stocks. And the performance of commodities mutual-funds has striking parallels to the broad U.S. stock market.
Funds that track the benchmark Standard & Poor's 500 stock-index (SPX 1,102, +6.39, +0.58%) rose 24% this year through Dec. 10, while commodities funds were up about 20%, according to fund-tracker Lipper Inc. Over three years, the S&P funds lost an average of 6.6% annualized; commodities funds were down 7.3% on average.
Gold, meanwhile, has been an effective diversifier, with gold funds gaining 10.6% on average over the three-year period.
"Everyone thought that if you invest in long-only commodities, you'd get diversification, but that's not the case," said Nadia Papagiannis, alternative investments strategist at investment researcher Morningstar Inc. "We found out last year that they were very highly correlated [to stocks]."
Marching together
Even as commodities and stocks prove close cousins, the money management industry and financial advisers frequently pitch commodities as diversification tools. More than half of the commodities mutual-funds and exchange-traded funds on the market have been introduced since the start of 2008, and investors have socked increasingly large amounts of cash into these products.
In some ways the fact that commodities and stocks have been moving in the same direction is intuitive, particularly given the type of crisis the market suffered last year.
The credit crunch caused a near-unprecedented liquidity squeeze, which affected not just stocks but also led to a drying up of demand for most commodities. As such, commodity values fell in near-lockstep with stock prices, particularly late in the year.
From Sept. 1 to Dec. 31, 2008, as the S&P 500 plunged 30%, oil fell 66%, corn dropped 28% and copper was down 62%.
Gold, however, did hold up as a diversifier. While the precious metal's price fell 17% in October 2008 -- the same as the S&P 500 -- it was up in September, November and December, and finished the September to December period up 6.6%.
At the same time, the fund industry has boosted the number of retail commodities funds. Of the 85 commodities mutual funds, ETFs and exchange-traded notes, 42 came to market last year, and five were launched this year through Oct. 31, according to research firm Strategic Insight.
Investors have responded to the rapid rollout: Through Oct. 31, more than 7% of inflows into stock funds and ETFs -- $27.5 billion -- went to commodities funds, said Strategic Insight.
