Low Risk Commodity Investing for Inflation Protection
June 2, 2009 by Mr. GoTo
Filed under Investing for Retirement
Most investors know that gold and other precious metals have a reputation as an inflation hedge. Actually, commodities in general are an asset that baby boomers and retirees should consider owning to protect against significant inflation damage.
As older investors – and having experienced the market decline of 2008 – we need to be careful. That includes finding ways to invest in non-correlated asset classes that carry lower risk. There is a way to do that with commodities.
Low Risk Commodity Investment: CTI
Standard & Poor’s has created and publishes a special commodities pricing index known as the Commodity Trends Indicator (CTI).
The CTI essentially factors in predictions for prices to rise or fall for different commodity types. In other words, the managers of the indicator estimate where a specific commodity price is within in its normal price cycle. For example, the CTI might hold futures contracts that will profit from wheat or oil prices rising (i.e., a long position). At that same point in time, the CTI managers might say that you should sell gold futures “short”, based on a prediction that the price of gold will fall.
The CTI is based on a diversified combination of 16 different commodities. These are tracked in six different sectors: energy, industrial metals, precious metals, livestock, grains, and “soft commodities” such as cocoa, coffee, cotton and sugar.
The CTI may go long or short in any of the sectors except energy. It is believed that a war or other chaotic event in Middle East makes energy too risky to short.
CTI performance is interesting. From 2004 (when it started) through May 29, 2009, the CTI doubled. During this same period, the S&P 500 index fell 8%. Other commodity indicators that do not do any short selling did much worse.
If the CTI actually existed over the past ten years, back-testing tells us that it would have returned 12% annually through 2008. During that same ten year period, the S&P 500 actually fell 1.4% on an annualized basis.
How to Invest in the Commodities Trends Indicator
There is one mutual fund today that follows the CTI: The Direxion Commodity Trends Strategy Fund (DXCTX).. There is also an exchange traded fund (a note actually): The Elements S&P CTI ETN (LSC).
There are two weaknesses with these investment options. Annual expenses for the Direxion fund are almost 2%. The Elements ETN expenses are better at 0.75% per year. However, because this ETN is actually a debt instrument of the sponsor, you could lose some or all of your investment if the issuer failed.
Rumor has it that Claymore Securities will soon launch its own CTI-based exchange-traded fund. Assuming that its expenses are low, that will be a less-risky alternative.
Final Thoughts on Inflation Protection from Commodity Investments
The subject of investing and inflation is more important now than perhaps ever. There are different strategies available to us, such as building a Treasury ladder. My feeling is that if the prices we pay for oil, food, and other commodities are going to rise, we should find some way of benefiting from that. The CTI investing plan is one way to do that.
Photo credit: Tommy Ironic
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