Two books I've read that have kind of built up to having this conversation. Principles by Ray Dalio, and All About Asset Allocation by Richard A. Ferri.
In the second book, All About Asset Allocation, Ferri has the following to say about choosing assets:
Asset classes you should include in your portfolio should have 3 characteristics: 1) low correlations with other assets, 2) positive real return, 3) and easily investible. With this I completely agree. With this in mind, he argues that commodities fail the second point.
"Commodities and precious metals are good examples of asset classes that historically have no real return. These asset classes are often touted as having occasional negative correlation with stocks and bonds which consequently lowers portfolio risks at times. However, there is no real return benefit from the money allocated to these investments over the long term....Stocks and bonds are for investing; commodities are for speculating. Commodities include physical assets and futures conracts that track the price of everything from wheat to gold to pork bellies. These are not growth assets. A ton of copper today will be a ton of copper 10 years from now and 100 years from now, and a ton of copper pays no dividends or interest. Price volatility alone does not generate an inflation-adjusted return from an investment. It is cash flow that drives real returns higher. The earning growth from corporate stock that leads to cash dividends, interest income from bonds, rents from real estate, and the known scarcity value of collectibles such as rare coins are things that create real wealth. Commodity prices will go up and down with the volatility of stocks, but they will not deliver the return of stocks because they have no ability to create cash income. The way people make money in commodities is to be on the right side of a price trend. Consequently, timing is everything. You could make money in commodities if you are one of the rare people in the world who has superior information about future supply-and-demand trends and then convert this knowledge into skillful trades, or if you get lucky and guess right on future prices."
This seems somewhat intuitive and matches up mostly with my udnerstanding of the main driver for commodity prices, a supply and demand shifts causing a tight market or a surplus. However, I'm confused by his use of rare coins as an alternate example of something that he considers produces ral return. To me they are the same, one rare coin does not becaome two rare coins. It's value changes based on supply and demand, or what he calls scarcity value. Though this does not invalidate the argument against commodities for me, I would just put rare coins in the same category as commodities rather than equities/bonds/reits.
But then I think about some other well-know portfolio constructs. The Ivy League portfolio has 20% in commodities and Ray Dalio's all-weather portfolio has a commodity allocation as well. So my question is this. What type of smart is Ray Dalio? Obviously he is a brilliant guy. But is he so smart he himself and Bridgewater can constantly be on the right side of a price trend, and his recommendation is not to invest in commodities, but invest in commodities managed by Bridewater? Or is he smarter than Ferri and his better understanding of commodities let's him see their real value in a portfolio?
Submitted December 11, 2018 at 10:38AM by dipsis https://ift.tt/2QR1Q96
