Should a commodity hedge be your cup of tea?

Dear Reader,

Past week was once more populated with a number of events leading to higher geo-political uncertainties. While Iran showed its real intentions by firing 200 missiles on Israel, the war in Gaza and in Ukraine continues and the US is subject to a significant strike in the harbours to impact potential reignition of inflation, with larger economic impact dependent on how long it lasts, Chinese leader Xi Jinping vowed for ‘reunification’ with Taiwan on eve of Communist China’s 75th birthday. No wonder stock indexes took a dip... and there was a flight to safety.

In case of a world conflict nearing there is no doubt that this will impact the economies of all and every country in the world. Equities as well as bonds will act in concert and go down in value, the 60/40 portfolio will have no hiding places then. Therefore it is good to have some buffer or hedge and the only asset class that will provide this buffer or hedge is commodity.

Many portfolio managers advise to add commodities into the portfolio but not many advise on the percentage. This advice is indeed a particular difficult one, because it depends to a large extent on the risk appetite and logic of the individual investor. In a very broad way one could say that it is wise to allocate something like 1 to 5% in every portfolio. In my personal portfolio I have chosen for 2% in commodities and will explain you how I constructed this.

First of all you need to follow the rules of diversification and so this means you choose a well known and broad index. I chose the Bloomberg Commodity Total Return Index ("BCOMTR") and the corresponding ETF from iShares: iShares Diversified Commodity Swap UCITS ETF. This ETF has $1.3B in AUM and quotes on a number of stock exchanges amongst which the London Stock Exchange. This makes it easy to follow in European time and on the LSE. It quotes in USD and GBP in London and in EUR on Xetra with almost the same liquidity and volumes. The ticker symbol is "ICOM.L" and the Total Expense Ratio is 0.19% which is very acceptable.

Not that it is a synthetic ETF however, meaning it does not buy the underlying commodities but replicates the index by use of swaps on futures. For Belgian investors this means also it is subject to Reynders tax and FIFO rules, which has tax implications and I elaborated on in an earlier post already. But apart from the Reynders tax and FIFO it is a perfect instrument.

By definition commodities have no yield, they just serve as an instrument of hedge against USD and inflation, no more no less. The Bloomberg Commodity Index is composed as this:

It is rebalanced every year and we notice that roughly 30% is in "energy" (50/50 oil and gas) while almost 15% is in gold and another 5% is in silver. The rest is agricultural, livestock and other industrial metals and "softs" like sugar, coffee and cotton. So I want to divide my 2% target spread over 60% in ICOM (a broad diversification but knowing 15% of this is already in gold) and add 40% in extra gold as a "correction". The idea is to obtain in the end roughly 50% in gold and 50% in "other". For the gold addition I chose for the physical delivery Xetra-Gold? (WKN: A0S9GB / ISIN: DE000A0S9GB0) ETF (ticker "4GLD on Xetra) and on which I reported also already in a previous post this year.

So a snapshot of my current hedge looks like this:

My YTD performance of the combined positions is +8.3% and we notice that the largest part of this is due to the gold component. Gold Continous Contract on the futures market indeed rose almost 30% YTD. Something must be going on... ??

Enjoy the upcoming weekend and cheers as always,

Luc