"This is my land. And you know it's rich with gold. Goooolllldddddd." The self-proclaimed “greatest prospector in the north” spent his days searching for gold and trying to avoid the abominable snowman, until he meets Rudolph the Red-Nosed Reindeer and his band of misfit toys (this link is worth a click). We can’t help but think that if Yukon Cornelius had first met with GreenPort Capital Advisors, he would have spent his days searching for stocks with high growth potential and reasonable multiples, instead of gold. He would be much better off financially and it certainly would have made for a more exciting cartoon adventure. While some of you may disagree with the latter point, it’s hard to disagree with the former. With gold prices recently popping higher, we are understandably being asked by several modern-day Yukon Cornelius, “why don’t we have Gold in our portfolios”? The reason is that gold, and commodities as an asset class, have poor long-term risk and return characteristics. Commodities can be broken down into 3 main subgroups, precious metals, energy, and agriculture. While agriculture has a slightly better risk premium than metals or energy, no subgroup is attractive as a long-term investment. A common misconception among investors is that the change in the spot price of a commodity is synonymous with the investor’s return. It’s almost a universal truth that the investor receives far less than the change in spot price would suggest. This is because of “negative carry cost”. When you buy a commodity, let say oil, you don’t buy the physical commodity but rather a future on the commodity. For example, if you wanted to invest $10,000 in oil and oil was trading at $50 a barrel, you would buy 200 barrels of oil. An investor, however, does not buy physical barrels of oil (spot price), rather the investor buys a futures contract on the price of oil. To buy actual physical oil the investor would need to have the barrels shipped to his house, build a warehouse to store the barrels, and then pay to have the barrels reshipped when he decides to sell the oil. There would be a large cost involved with that. A futures contract allows the investor to avoid this unrealistic logistic, however, the contract factors in the cost of someone else bearing these costs. Therefore, the net gain to an investor is usually far less than a spot price would suggest. Below is a table showing the return an investor would have received on an investment in U.S. Stocks (S&P 500), U.S. Bonds (Barclay’s Aggregate Bond Index), and Commodities (Goldman Sachs Commodity Index), Gold, and Oil over various time periods. It's no wonder Yukon Cornelius would lick the end of his ice pick and snarl "nothin"!
Longer-term returns aren’t quite as dramatic, but the pattern is similar. This is why at Greenport we don’t include commodities in our strategic allocation of the Core Portfolios. In very rare circumstances, such as a high inflation environment, we may invest tactically to take advantage of a short-term surge in commodity prices and to protect the portfolio's purchasing power. Regardless of the time period the evidence is clear, the only time investing in commodities, and gold in particular, has been advantageous is during periods of rapidly rising inflation such as the late ’70s. Globalization and technology have been, and we expect will continue to, banish inflation to the island of misfit toys. Even when we include the hyperinflation period of the late '70’s, Gold is an asset class that provides less return and more volatility. That’s not a desirable characteristic for optimal portfolio construction.
On a bit of a side note, the abysmal returns on oil investing are somewhat encouraging to proponents of clean energy. It is also a warning to continue questioning conventional wisdom. During the '70s, the experts assured us oil reserves would be depleted by the mid-'80s. 15 years ago the mantra around smart investors was "peak oil", the forecast that we were running out of supply due to increasing demand from emerging markets. "Buy now, prices are sure to go higher", we were told. Today the world's oil reserves are higher than they have ever been. We all know price is a function of supply and demand. So while supply has greatly outpaced expectations due to fracking and advancements in technology, demand has not increased proportionately. Perhaps cleaner energies are finally becoming more economically viable to the average consumer. At a minimum, we are becoming more efficient in our use of carbon-based fuels. We'd argue that flying reindeer were the original alternative energy, The GreenPort Team