The launch of the much anticipated iShares Silver Trust (SLV) is indicative of a turnaround in conventional wisdom towards commodity investing. Not all that long ago commodities were an anathema to most portfolio managers/asset allocators. However the tide has turned and an allocation to commodities is now conventional wisdom. Lisa Scherzer at interviews a high-level investment executive that perfectly captures the change in attitudes towards commodities.

What lead to the legitimization of commodities as a core portfolio asset? Clearly the return-chasing behavior of many investors has lead them to seek out evidence that justifies their behavior. Fortunately for them an academic paper arrived on the scene at exactly the right time.

"Facts and Fantasies about Commodity Futures" by Gary Gorton and K. Geert Rouwenhorst found substantial evidence for the inclusion of commodities in an portfolio. They found collateralized commodity futures have had similar returns to equities while being negatively correlated with equity and bond returns. In addition they found commodity returns to be positively associated with concurrent and unexpected inflation.

This is indeed nirvana for asset allocators – equity-like returns from a portfolio diversifier. While there is some dissent from their conclusion among academics, their research was picked up by multiple media sources as a major discovery. The question for investors is whether their results, and subsequent investor behavior have changed the investment equation for commodity investment?

One prominent investor seems to think so. Bill Miller of Legg Mason Capital Management in his April 2006 Market Commentary examines the current consensus on commodity investment and finds it lacking. While we would encourage you read the entire piece a couple choice excerpts.

The reason to own commodities may be that one believes they provide equity like returns with little correlation with equities. The time to own commodities is (or at least has been) when they are down, when everybody has lost money in them, and when they trade below the cost of production. That time is not now. The data showing the returns of commodities will look very different if you start measuring just after prices have tripled.


Today people want commodities, emerging market, non US assets, and small and midcap stocks. Those were all cheap 5 years ago and had you bought them then you would be sitting on enormous gains. But 5 or 6 years ago, everyone wanted tech and internet and telecom stocks, and venture capital and US mega caps. The time to buy them was in 1994 or 1995, when they were cheap. But in 1994 or 1995, people wanted banks and
small and mid caps, which should have been bought in 1990, and well, you get the picture.

We as investors can get ourselves into trouble when we begin to misidentify the time frame of our investments. It may make perfect sense to hold commodities over the long run. However to make the case for commodity diversification after a substantial price move is a short term bet on the continuation of the current bull market. While commodities may be a legitimate asset class, we should never confuse brains with a bull market.

In regards to the silver ETF, Greg Newton at NakedShorts suppresses a big yawn. Market Participant writing at ETF Investor has a substantive critique of all of the metal ETFs. They argue that these funds are inherently flawed because they do not take advantage of an income producing opportunity, i.e. bullion lending. Because of this these ETFs have an inherent value drain. For those interested in these vehicles the post is worth a look.

Hat tip to for a pointer to the Bill Miller commentary.