Recently, Canadian Capitalist asked whether Canadians should add commodities to their portfolios. On the surface, I couldn’t understand why a hunk of copper would be expected to perform as well as the stock market. However, when we say “commodities”, we are actually referring to commodity futures. (No doubt Canadian Capitalist understands this well.) Futures differ from the commodities themselves in important ways.
There is no reason to believe that commodity futures will give the same returns as the commodities themselves. When we buy a copper future, the price will reflect not only the current price of copper, but also the uncertainty in the future value of copper. Like any other derivative, commodity futures have time value.
If an investor buys a one-year copper future, sells it a year later, and buys another one-year copper future, there is no reason to believe that the sale price of the first future will match the purchase price of the second future. However, actual copper will maintain constant value during the few seconds the investor was making the futures trades.
I’m convinced that owning commodities directly is unlikely to beat investing in the stock market. After all, we keep getting better at growing things and digging things out of the ground more cheaply. A possible exception is commodities that are being exhausted, like oil.
However, commodity futures could easily perform very differently from the commodities themselves. The price of a future will reflect a risk premium. The more perceived risk, the greater the expected return. None of this proves that commodities futures are a good investment, but it is possible.