Data &
Technology
Research
Reports
Report Solutions
Reports Library
Actionable
Strategies
Free
Resources
Simple Backtest Calculator
Simple Seasonality Calculator
The Kelly Criterion Calculator
Sentiment Geo Map
Public Research Reports
Free Webinar
Pricing
Company
About
Meet Our Team
In the News
Testimonials
Client Success Stories
Contact
Log inLoginSign up
< BACK TO ALL REPORTS

A Case for Commodities in the Years Ahead (Part II)

Jay Kaeppel
2021-05-18
There is a long history of back-and-forth between stocks and commodities. In Part II, we detail a potential strategy for playing the trend in this relationship.

In Part I, I argued the following points:

  • Stocks have significantly outperformed commodities on a buy-and-hold basis over the long-term
  • However, there are massive swings back and forth and periods of time when commodities vastly outperform stocks
  • Stocks presently appear to be overvalued on a long-term basis and may experience much weaker returns in years ahead
  • Commodities are historically cheap relative to stocks

TAKING ADVANTAGE OF STOCK AND COMMODITY SWINGS

Given that:

  • There are periods of times when the stock market performs poorly, AND
  • Commodities often perform extremely well when stocks perform poorly
  • We will attempt to build a simple model to tell us whether to favor stocks or commodities at any given point in time

For our test, we will use the following indexes from 10/31/1933 through 4/30/2021 using the monthly closing price for each:

  • S&P 500 Index (SPX)
  • Bloomberg Commodities Index (BCOM)

The indicator we will use to time switches from stocks to commodities and back uses the following variables and formula:

A = Growth of $1 in Bloomberg Commodities Index

B = Growth of $1 in S&P 500 Index

C = A / B

D = 15-month EMA of C

E = C - D

TRADING RULES

  • If C>D then hold commodities during the next month
  • If C<D then hold stocks during the next month

In a nutshell:

  • We track the ratio of commodity performance divided by stock performance 
  • We apply a 15-month moving average 
  • If the current ratio is above the moving average, we will hold commodities
  • If the current ratio is below the moving average, we will hold stocks

The chart below displays the Commodities/Stocks ratio (Variable C) along with its 15-month EMA (Variable D)

The chart below displays Variable E, the Commodities/Stocks ratio MINUS its 15-month EMA

To get a better sense of recent action, the chart below "zooms in" on the chart above and focuses solely on the last 15 years (May 2006-April 2021).

The key things to note:

  • The value has been negative (i.e., favoring stocks) for almost 10 full years
  • The gap has been narrowing of late and may soon exceed 0 once again (i.e., favor commodities)

The action of the markets in the last 10 years has led to a hardening of the "buy stocks, avoid commodities" mindset.   However, the longer-term picture argues against adopting this rigid mindset.

RESULTS

So now let's test our simple strategy of:

  • Holding commodities when Variable E is above 0
  • Holding stock when Variable # is below 0

Things to note:

  • We will compare this approach to splitting money 50/50 between commodities and stocks and rebalancing to a 50/50 split at the beginning of each new calendar year
  • All results are hypothetical only and include price-only returns (not total return including dividends)
  • The results DO NOT include any deductions for trading costs such as slippage and commissions

As a benchmark, $1,000 invested buy-and-hold:

  • In commodities = $17,478
  • In stocks = $466,648
  • Split 50/50 between commodities and stocks and rebalanced at the start of each year = $177,615
  • By contrast, $1,000 invested using the switching system described above grew to a hypothetical value of $2,461,956

The chart below displays the hypothetical growth of the "switching" strategy versus the "50/50 split and rebalance" strategy.

The table below puts some facts and figures to the chart above (based solely on price data, NOT total return).

While the "Switch" strategy enjoyed significantly higher hypothetical gains over time, this higher return came with a significant absolute level of risk and volatility and a higher level of risk and volatility than that of the "Split" strategy.  Notably:

  • The average 12-month Standard Deviation for the "Switch" strategy was 20.3% versus 13.5% for "Split"
  • The maximum % drawdown for the "Switch" strategy was a substantial -56.2% versus -49.7% for the "Split" strategy

PLAYING THE STRATEGY

The strategy detailed above is presented for informational purposes only and not as a "recommendation." Given the volatility and significant drawdowns highlighted in the hypothetical backtest, an investor should carefully consider whether this type of strategy fits their own personality.

That said, to complete the example, one simple approach for an investor considering this type of strategy would be to:

  • Buy ticker GCC (WisdomTree Continuous Commodity Index Fund ) when the strategy favors commodities
  • Buy ticker SPY (SPDR S&P 500 ETF Trust ) when the strategy favors stocks

Ticker GCC is an ETF designed to track The Continuous Commodity Total Return Index, a broad-based commodity index that reflects the price movement of 17 exchange-traded futures contracts and serves as a proxy for commodities as an asset class. 

Ticker SPY holds the 500 components that comprise the S&P 500 Index and serves as a proxy for stocks as an asset class.

An investor can gain exposure to either stocks or commodities as an asset class by trading ETFs by buying one broadly diversified portfolio.

Sorry, you don't have access to this report

Upgrade your subscription plan to get access
Go to Dasboard
DATA &
TECHnologies
IndicatorEdge
‍
BackTestEdge
‍
Other Tools
‍
DataEdge API
RESEARCH
reports
Research Solution
‍
Reports Library
‍
actionable
Strategies
Trading Strategies
‍
Smart Stock Scanner
‍
FREE
RESOUrCES
Simple Backtest
Calculator
Simple Seasonality
Calculator
The Kelly Criterion
Calculator
Sentiment Geo Map
‍
Public Research Reports
‍
Free Webinar
COMPANY
‍
About
‍
Meet our Team
‍
In the News
‍
Testimonials
‍
Client Success Stories
Pricing
Bundle pricing
‍
Announcements
‍
FAQ
© 2024 Sundial Capital Research Inc. All rights reserved.
Setsail Marketing
TermsPrivacyAffiliate Program
Risk Disclosure: Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones’ financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.

Hypothetical Performance Disclosure: Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. for example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.

Testimonial Disclosure: Testimonials appearing on this website may not be representative of other clients or customers and is not a guarantee of future performance or success.