I'll never forget my first meeting with uber-investor and hedge fund manager, Jim Rogers. He was my market hero of sorts, having founded the Quantum Fund with George Soros. He has explored the world by motorcycle and automobile, all while writing about his adventures and being a fixture on financial news TV shows. I have met some quirky characters in the financial markets, but he was the first to chat with me while jogging on a treadmill.
He has reinforced the notion that commodities are different from stocks in that they represent life's necessities rather than simply a company's profits. Commodities are all around us and are far simpler investments than stocks -- they're purely driven by supply and demand.
This is particularly true regarding the so-called "soft" or agricultural commodities such as wheat, soybeans, corn, sugar, cotton and coffee. These items are among life's few necessities and therefore possess constant demand from an ever-growing global population. Soft commodities are uncorrelated to the stock market, so they offer excellent diversification for a crisis portfolio.
That's why a well-diversified portfolio designed to withstand an economic crisis should have between 5-25% allocated to soft commodities. During times of low interest rates such as the Federal Reserve's "easy money," for example, investors should allocate at the lower percentages. As soon as the Fed starts to tighten policy and raise interest rates, ramping up your exposure to soft commodities up to the 25% weighting has traditionally been a smart move.
How to invest
When most investors think of soft commodities, they think of the open futures markets. While this is the primary way of trading soft commodities, it takes a special futures account to access this market directly. Fortunately, investors can have exposure to soft commodities through exchange-traded funds (ETFS) or exchange-traded notes (ETNs).
Let's look at the three most popular soft commodities -- sugar, cotton and coffee -- and a few ways to invest in them collectively or individually...
|1. Futures Contracts|
|iPath Dow Jones-UBS Softs ETN (NYSE: JJS) and the Pure Beta Softs ETN (NYSE: GRWN) are both very similar ETNs with a 0.75% expense ratio, but are different in the way they choose to invest into the same future contracts. JJS simply rolls the investment into the next expiring futures contract, whereas GRWN seeks to choose the contract that most represents the returns largely representative of the particular commodity.
While this may seem like a very minor point, GRWN returns are more in line with actual spot prices of the three commodities reflected. The downside of investing in these two ETNs is that the volume is very light for both of them, usually around 1,700 shares a day for GRWN and 5,000 daily shares for JJS.
Investors who want to invest individually into one of the three largest soft commodities, these ETFs fit the bill...
|Teucrium Sugar Fund (AMEX: CANE) is an ETN seeks to follow the daily changes of a weighted average of the closing prices of three sugar futures contracts.
Sugar has been downtrending in price since April 2012 and is trading below its 50- and 200-day simple moving average. There has been an oversupply glut in the sugar market resulting in the persistent downtrend. However, price is approaching levels that are considered to be historic buying zones.
Cotton prices have been trending higher since November, but shares of iPathDJ:UBS Cotton Sub Index total return (AMEX: BAL) have recently hit resistance in the $54 range.
The share price is above the 50- and 200-day simple moving averages. This ETN is designed to reflect the returns of an investment in unleveraged cotton futures. The stock has bounced from the lows, setting up a potential long entry on a breakout close above $55.
|iPath Pure Beta Coffee ETN (AMEX: CAFE) is an ETN that follows the Barclay Capital Coffee Pure Beta TR Index. Aggressive harvesting has led to oversupply that has the black bean downtrending since early 2011.
Prices are well below the 200- and 50-day moving averages as investors wait for signs of a rebound from these historical low levels.
Risks to Consider: Agricultural commodity investing is very speculative and risky. Although there are long-term price trends, trying to time the bottom or top can be an exercise in futility. Commodities can be extremely volatile and take much study to be able to completely understand their movements.
Action to Take --> Most investors would be wiser to simply add a small percentage of the combined soft ETNs such as GRWN and JJS as way to hedge their stock portfolio against economic crisis. Attempting to time the individual softs is time consuming and overly risky for the average investor. Although soft commodities have been downtrending overall, they are reaching levels that are considered to be "buy" zones among professional investors.