While commodity assets and related exchange traded funds have been among the most hated investments, the outlook for the asset class could turn around during a rising interest rate environment.
Tim Strauts, senior market research analyst for Morningstar, argues that real assets, like commodities, typically outperform other asset classes during periods of restrictive monetary policy, or when the Federal Reserve enacts a tight monetary policy defined by an increasing discount rate and rising Federal funds rate.
Meanwhile, Strauts points out that stocks are among the worst performers during a restrictive monetary policy.
Specifically, looking at asset class performance from February 1972 through April 2015, commodities have generated an average negative performance during periods when the Fed followed an easy-money policy. In contrast, during restrictive periods, commodities and gold assets outperformed real estate investment trusts, U.S. stocks and international stocks, according to Morningstar data.
“Commodities and gold perform best in a restrictive period and worst during an expansive period,” Strauts said. “Commodities have underperformed for the last three years, but we may be moving into a period of rising interest rates. If that happens, commodities may break out of their performance slump and start outperforming other asset classes again.”
Strauts argues that it is prudent to allocate to real assets like commodities as a restrictive monetary policy is likely to occur over the next few months to few years. [Is it Time to Buy Commodities?]
Consequently, investors can cover the broad commodities space through related ETFs. For instance, the GreenHaven Continuous Commodity Index Fund (NYSEArca: GCC), PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC), iPath Dow Jones-UBS Commodity Index Total Return ETN (NYSEArca: DJP) and iShares GSCI Commodity-Indexed Trust (NYSEArca: GSG) provide broad exposure to commodities. [Commodity ETFs Provide Diversification and Protect Against Inflation]
GCC follows an equal-weight methodology that covers 17 commodity positions. DBC, the largest commodity-related ETF, tracks a broad basket of the 14 most heavily traded commodities and uses an optimum yield methodology that tries to limit the negative effects of contango. DJP is an exchange traded note that tracks the Bloomberg Commodity Index Total Return. Lastly, GSG tracks the widely observed S&P GSCI Total Return Index. It should be noted that these broad commodity ETFs also include a heavy tilt toward the downtrodden energy market.
Additionally, investors may also gain direct exposure to specific commodities through ETFs. For instance, for gold exposure, the SPDR Gold Shares (NYSEArca: GLD), iShares Gold Trust (NYSEArca: IAU) and ETFS Physical Swiss Gold Shares (NYSEArca: SGOL) are all backed by physical gold bars stored in New York, London or Swiss vaults.
For more information on the commodities market, visit our commodity ETFs category.
Max Chen contributed to this article.