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The Best Buys In Commodity Funds – Forbes

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Antidote to inflation: Own some precious metal and a few hogs.

Inflation is creeping up, from 1.6% just before the election, as measured by price changes over the trailing 12 months, to 2.2% recently. How are your bonds doing? Probably not too well.

Maybe you could use an inflation antidote—like commodities. This is a wild bet with a rational basis. Wild, because commodities have delivered such rotten results over the past decade. But rational, because prolonged inflation is sure to damage a fixed-income portfolio and likely to help out things like precious metals, soybeans and oil.

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So says Maxwell Gold, director of investment strategy at ETF Securities. This aptly surnamed guy is talking his book: His employer is a $23 billion manager of exchange-traded funds, predominantly invested in precious metals. But he has data to back up the idea of using commodities as an insurance policy. Over the past 26 years, he calculates, a 10% allocation to commodities would have trimmed the annualized volatility of a 60/40 stock-and-bond portfolio from 8.5% to 7.6%.

There are several ways to get your exposure to commodities. You could buy futures contracts in Chicago, investing a fair amount of effort to roll them over before they mature and perhaps worrying that if you forget to do that you’ll wind up with 5,000 bushels of wheat on your lawn. You could, at considerable expense, hire a commodities trading advisor to do the futures trading. Or you could buy a commodity fund.

For most investors, funds are the right choice. Good news on that front: They’re getting cheaper.

Commodity ETFs

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Commodity ETFs

Among commodity ETFs, the granddaddy is Invesco’s PowerShares DB Commodity Index Tracking Fund, with $2 billion of shares outstanding. Expense ratio: 0.85%, or $85 a year for every $10,000 invested.

Since that fund opened for business in 2006, ETF vendors have been in a price war. In 2014, Invesco opened a sister fund, PowerShares Optimum Yield Diversified Commodity Strategy No K-1 Portfolio, with an annual fee of 0.6%. This year ETF Securities chopped the fee to 0.29% on two new broad-basket commodity funds (see table).

Despite a burst of prosperity in 2016, long-term investors in funds like these have not fared well. In the past ten years PowerShares DB has delivered a compound annual return of -5%. And yet commodity bulls can come up with three reasons why their misery will end.

One is scarcity. The planet has only so much tin ore and arable land.

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Next is the desire of producers to offload risk onto speculators, for which speculators ought to be compensated. A farmer might be willing to sell hogs now worth $1 in a futures contract at 99 cents, in order to lock in a spread over feed costs. This pricing pattern is called backwardation, and when it happens it’s a blessing to investors on the long side of the futures trade. They can pick up a penny of profit in a flat market.

The third reason for optimism is at the Federal Reserve, whose loose-money policies of the past decade are likely to be reversed in the next one. Jason Bloom, a global market strategist at PowerShares, says that, historically, commodity indexes have delivered 18% annualized returns during episodes of Fed tightening.

Now hear out two reasons to be bearish. The first is that many commodity markets, most of the time, experience contango, the opposite of backwardation. This has to do with the cost of stockpiling. A dollar’s worth of gold trades in the futures market at $1.01, the extra penny covering the cost of financing the metal and hiring someone with a rifle to stand outside the vault. In a sideways market people who own either gold futures or gold bars get poorer, a penny at a time.

The other problem is technology. Shale drilling and genetically modified seeds have created abundance where there used to be scarcity.

So, should you be bullish or bearish? Maybe neither. Think of owning commodities as purchasing insurance rather than stepping into a windfall.

Insuring against inflation is going to cost you money, whether you do it via a commodity fund or do it by accepting low yields on inflation-protected Treasury bonds. Maxwell Gold, the analyst at ETF Securities, concedes as much: His study showing commodities shaving 0.9 percentage points off the volatility of a balanced fund also has them trimming 0.2 points off the annual return.

Our advice: Buy a fund, not futures. Get the cheapest one. Be aware of the quirky tax rules or, better still, put your fund in a tax-deferred account.