How to Invest in Commodities – Fund Spotlight Series – Part 1

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Why invest in commodities? And why now?

If you are questioning why commodities would make a good investment, you are not alone. Here’s what Warren Buffett had to say about one of the most famous commodities, gold:

Why Invest in Commodities?

 

“If you took all of the gold in the world it would roughly make a cube 67 feet on a side. Now for that same cube of gold it would be worth at today’s market prices about $7 trillion. That’s probably about a third of the value of all the stocks in the United States. So you could have a choice of owning a third of all the stocks in the United States or you could have a choice of owning that little block of gold, which can’t do anything but kind of shine there and make you feel like Midas or Croesus or something of the sort.

Now, for $7 trillion, there are roughly a billion acres of farmland in the United States. They’re valued at about $2 1/2 trillion. It’s about half the continental United States, this farmland. You could have all the farmland in the United States, you could have about seven ExxonMobiles, and you could have $1 trillion of walking around money. And if you offered me the choice of looking at some 67-foot cube of gold and looking at it all day, you know, I mean touching it and fondling it occasionally, you know, and then saying, you know, `Do something for me,’ and it says, `I don’t do anything. I just stand here and look pretty.’ And the alternative to that was to have all the farmland of the country, everything, cotton, corn, soybeans, seven ExxonMobiles. Just think of that. Add $1 trillion of walking around money. I, you know, maybe call me crazy but I’ll take the farmland and the ExxonMobiles.

 

– Buffett said this in a March 2011 interview on CNBC. (You can read the whole transcript of the Buffett interview, here.)

Why Invest in Commodities Now?

It seems we are beginning to see the economy make a turn towards normalcy. GDP growth just hit 3.1%, prices for goods as measured by the Producer Price Index have ticked up (see below) and company CEOs have been talking about rising prices lately.

latest_PPI_producer_price_indexGS rising prices

And the latest ISM (Institution for Supply Management) PMI release:

The Prices Index registered 71.5 percent in September, a 9.5 percentage point increase from the August level of 62, indicating higher raw materials prices for the 19th consecutive month.

 

 

commodity_supply-prices

 

At a time all of this is happening, commodities are coming off of their worst performance stretch in decades:

commodities undervalued chart history

 

Granted, last time commodities where so undervalued, they stayed that way for 20 years. So there is no promise of a quick payoff.
It is tough to argue against Buffett. $7 trillion in gold just sits there, earning nothing for the investor. $7 trillion in ExxonMobil stock (OK its market cap_ is ~$400 billion, but IF you could invest $7 trillion in an Exxon-like stock) would produce $268 billion per year in just dividend income, plus any capital appreciation. So I don’t think I want to own the gold. But i think owning the gold miners seems like a better way to “invest” in the commodity. Investments in commodity produces, such as miners, farmers, etc. should promise upside if the price of commodities rise, but also provide the ability for my investment to compound, pay dividends, etc.

Where to Start Investing in Commodities

****Update and spoiler alert: Exploring how to invest in commodities and commodity ETFs has led me longing for much more than just a big diversified commodity ETF. So this post will come in several parts. Below we compare some of the largest “all-in-one” commodity funds and start to delve into ETFs that focus just on the agriculture sector. Check back for updates (or sign up for our mailing list at the top of the page or sidebar to get notified). The next sectors that will be added are mining and metals, timber, and other “exotic” commodities!

There are a thousand different options to invest in commodities. Where do you start?

Initially I found a few problems looking through commodity ETFs:

1) They have high costs – The cheapest fund in our list below has an expense ratio of 0.39%. Not terrible, but certainly not as low as you can find a lot of other ETFs today. When you start looking at actively managed ETFs and mutual funds in this space, you will pay more than 1% annually in expense ratios very easily.

2) Not as Diversified – Maybe I am being picky here. But the holdings in every fund I looked at started to look the same. Huge allocations to the big commodity companies; ExxonMobil, Monsanto, Archer-Daniels-Midland, etc. I list the concentrations for each fund below. Most left me longing for more exposure to different sectors and companies besides the big names.

Investing in Diversified Commodity Producer ETFs

These ETFs give you an easy way to investing in a diversified group of companies involved in producing a wide range of commodities. Initially, I liked this idea because I don’t think I trust myself to pick a single commodity. Less reward this way, but much less risk. But in reality, these funds did not provide what I was expecting. I think you’ll see why, take a look:

 

GUNR – FlexShares Morningstar Global Upstream Natural Resources Index Fund

  • Expense Ratio: 0.46% Expense Ratio
  • Index: Morningstar Global Upstream Natural Resources Index
  • Holdings: 124
  • Yield: 2.80%, dividends paid quarterly.
  • Comments: I really like that this fund is designed a little bit different than other commodity producer funds. The fund keeps 30% allocations to Agriculture, Energy and Metals, and then a 5% allocation to Timber and Water. Most of the ETFs below weight their holdings based on market cap, so you get huge allocations to a specific sector. This fund caps the allocation to 30%, leaving you more diversified.

Even with the allocations set at 30/30/30/5/5, this fund still has a problem that I see with many of these ETFs – huge exposure to the “big names” in the sectors. The top 10 holdings of the fund make up nearly 40% of the fund’s assets. Half of your agriculture exposure in the fund is due to 3 names; Monsanto, Tyson Foods, and Archer-Daniels-Midland.

It is a “problem” (if you believe that it is one) you are going to have with pretty much any market cap weighted ETF. This fund tried to help spread out your allocation, but it is still very concentrated.

Top few holdings (these names are going to look very familiar by the end of this article!):

 

GUNR_holdingsThe fund lists country allocation:

GUNR-country-allocation

But in reality, I think it is safe to say that the fund is much more diversified as far as country allocations than it appears. Companies like Exxon and Monsanto do business all over the world…They give huge weight to the United States, but in reality their business makes money from all over the world (Only about 35% of Exxon’s upstream activities are in the U.S.).

 

Lastly, for those who may be concerned, this is the largest, most actively traded commodity producer ETF out there, with more than $4.5 billion in assets.

 

Learn more:

The fund’s prospectus can be found here: https://www.flexshares.com/etf/documents/prospectus/prospectus-gunr-summary.pdf?1507137472514

You can learn more about the fund on the fund’s website, here: https://www.flexshares.com/exchange-traded-funds/morningstar-global-upstream-natural-resources-index


GNR – SPDR S&P Global Natural Resources ETF

  • Expense Ratio: 0.40% Expense Ratio
  • Index: S&P Global Natural Resources
  • Holdings: 90
  • Yield: 2.0%, dividends paid quarterly.
  • Comments: At a slightly lower cost and slightly lower concentration to top holdings, this fund provides exposure to commodity producing companies as well.  Though the fund does say: “Maximum weight of each sub-index is capped at one-third of the total weight of the Index”, I am not sure it executes on that strategy. It groups agriculture and materials together into the same sector:
  • GNR_sector

 

So you have to dive deeper into the fund’s holdings to really determine the sector make up. Here’s an Excel spreadsheet of GNR’s holdings. I get about 14% towards agriculture, 46% towards mining and metal production. Not necessarily a problem, but before you invest, make sure you are happy with the holdings, because the sector breakdown is a little vague.

 

 

The fund’s top holdings:

GNR_top_holdings

The top 10 holdings are slightly less weight with GNR than GUNR. For GNR the top 10 holdings make up 35% of the fund’s assets. The fund has a slightly higher energy sector allocation, and slightly lower agriculture allocation. But since the big names are all the same and heavily weighted, I would not expect much difference between the two diversified commodity producer index funds. More on the comparison below:

 

Learn More:

You can learn more about the fund on the fund’s website, here: https://us.spdrs.com/en/etf/spdr-sp-global-natural-resources-etf-GNR

The fund’s prospectus can be found here: https://us.spdrs.com/public/SPDR_INDEX%20SHARES_PROSPECTUS.pdf

 

 

 

HAP – VanEck Vectors Natural Resources ETF

  • Expense Ratio: 0.50%
  • Index: VanEck® Natural Resources Index 
  • Holdings: 300
  • Yield: 1.89%, paid annually
  • Comments: Triple the amount of holdings compared to the other diversified commodity producer ETFs. Also note the annual dividend payment, which may not be optimal for dividend investors. This is a small fund, only $100 million in assets, but decent volume and liquidity.

Top holdings look very familiar, slightly heavier allocation to agriculture up top:

HAP_holdings

 

However despite the higher weight to Monsanto, in total the fund as a little less exposure to agriculture:

HAP_sectors

GNR vs GUNR vs HAP

The holdings of the funds vary slightly, but the performance of each funds effectively depends on the performance of the same few big oil, mining, and agriculture names. As you can see, performance of these funds over the last 5 years has been very similar. HAP with a little under performance due to less Ag exposure and concentration to smaller companies, which have lagged behind in performance:

HAP_vs_GNR_vs_GUNR

Here’s a little better breakdown of the average holdings for the funds:

HAP_vs_GNR_vs_GUNR_market_capVanEck has a slightly smaller median market cap with its additional holdings, which seems to be responsible for its underperformance.

(By the way, how bad of an investment have commodity companies been over the last 5 years?)

 

GUNR_vs_GNR_vs_spy

Ouch!

 

 

Key Takeaways For Investing in Diversified Commodity Producer ETFs

The three funds above all do a very similar job in allocating your investments in commodity producing companies. Two of the funds (GNR and GUNR) have mandates to limit the weights of certain sectors to 30%, VanEck’s fund does not, and tilts slightly smaller in average market cap.

 

When I set off looking for commodity ETFs, I thought a big diversified ETF like the ones above would be all I would need. But after looking at the holdings, I feel that these funds provide much higher oil exposure than I was originally looking for, and I don’t like the huge weightings into the top names in the sector.

So investing into one of these largest “all-in-one” commodity index funds was eliminated as an option for me.

 

So my search led to finding sector and industry specific commodity ETFs, hoping I could piece together a few small funds that would add up to properly diversified commodity exposure in my portfolio.

Investing in Sector Specific Commodity Producer ETFs

Agriculture

VEGI – iShares MSCI Global Agriculture Producers ETF

  • Expense Ratio: 0.39% expense ratio.
  • Index: MSCI ACWI Select Agriculture Producers Investable Market Index
  • Holdings: 123
  • Yield: 2.14% yield, paid monthly
  • Comments: A decent expense ratio for these types of funds. Here are the top holdings:

VEGI_etf_holdings

The top 10 holdings make up 56% of the fund! (and why is an India ETF, with very little agriculture exposure in here?!?) You might as well just buy the top 4 or 5 stocks here and pay no expense ratio.

However, some dividend/income investors may like the monthly dividend payments.

I will sum up my thoughts on these agriculture ETFs below after we take a quick look at a few more:

 

Learn more:

You can learn more about the fund on the ETF’s website, here: https://www.ishares.com/us/products/239652/ishares-msci-global-agriculture-producers-etf

The fund’s prospectus can be found here: https://www.ishares.com/us/literature/prospectus/p-ishares-msci-global-agriculture-producers-etf-8-31.pdf

MOO – VanEck Vectors Agribusiness ETF

  • Expense Ratio: 0.53%
  • Index: MVIS® Global Agribusiness Index
  • Holdings: 59
  • Yield: 1.22%, paid annually
  • Comments: A little less “Monsanto-heavy” at the top, but the top holdings are still 53% of the fund’s assets.

MOO_ETF_holdings

 

PAGG – PowerShares Global Agriculture Portfolio

  • Expense Ratio: 0.76%
  • Index: NASDAQ OMX Global Agriculture Index
  • Holdings: 43
  • Yield: 1.73%, paid quarterly
  • Comments: More expensive, and much more concentrated with only 43 holdings.

There are some big differences in holdings with this fund compared to the other two:

 

PAGG_holdings

 

 

 

How do these agriculture funds compare?

MOO_vs_VEGI_vs_PAGG_performanceWe can tell from the holdings that PAGG is a little different. Here is a little better breakdown:

VEGI-MOO-PAGG_market_cap

PAGG’s median company is half the size of the other two funds. Smaller cap stocks in this sector have been under performing, so it makes sense. However, this ETF provides a little better exposure to smaller companies than the first two funds listed.

 

CROP – IQ Global Agribusiness Small Cap ETF

  • Expense Ratio: 0.76%
  • Index: IQ Global Agribusiness Small Cap Index
  • Holdings: 55
  • Yield: 1.10%, paid annually
  • Comments: A focus on small cap stocks, which long term investors may like. Also heavier international allocation.

Top holdings:

crop_hoLDINGS

The fund definitely wins with the best breakdown of its investments by sector, which is really handy:

crop_SECTOR_BREAKDOWN

crop_country_allocation

Also worth noting – This fund is small, only $12 million in assets, and very low volume (trading 3 shares the day I am writing this!). Be sure you place your order responsibly, using a limit order.

 

The smaller cap holdings have hurt performance over the last year, but this fund has a stellar performance over the past 5:

CROPvsVEGIvsMOOvsPAGG

 

 Key Takeaway for Investing in Agriculture ETFs

Big Differences: MOO has an annual dividend payment compared to quarterly for the other funds. PAGG’s portfolio is quite different and weighted towards smaller companies. CROP is only invested in smaller cap companies and is allocated more towards international companies than the others.

 

How do these funds react when the prices of different commodities rise or fall? Here is a look comparing these three agriculture ETFs to the price of corn (yellow line below – and America’s largest crop by far), Soybeans (purple line below) and Bloomberg’s Agriculture Spot Index (orange line), which represents a wide variety of commodities:

Over the last 12 months:

 

Agriculture_ETFs_vs_commodity_prices-1yearOver the last 5 years:

Agriculture_ETFs_vs_commodity_prices-5years

Not as much correlation as I was expecting. But it does seem to follow a loose pattern. The performance of these agriculture ETFs was certainly affected by corn’s drop in price from mid 2014 through 2016. These ETFs all hit their lows just as corn did the same in early 2016. So I think it is safe to say that if you want to experience upside IF agriculture commodities rise in price, these funds could be a good way to go.




 

…To Be Continued

Check back for updates (or sign up for our mailing list at the top of the page or sidebar to get notified), next sectors that will be added is mining and metals sector, timber sector and other “exotic” commodities!

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