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UBS Global Asset Management calls commodities 'inexact and unstable inflation hedge'
Report Challenges Conventional Wisdom Citing a history of underperformance and volatility in commodities, UBS Global Asset Management today released a report challenging the commonly held notion that investing in commodities as an asset class provides a reliable hedge against inflation.
"Commodities are a very inexact and unstable inflation hedge," according to Brian Singer, Regional Investment Officer for the Americas and head of the Global Investment Solutions (GIS) team for UBS Global Asset Management. "It is precisely the lack of correlation between commodities and any other asset class that suggests that they should not return anything in excess of cash."
With commodity prices up about 150% since the end of 2001, investors may be drawn to commodities as a potential investment opportunity, according to Singer. "Many organizations are considering passive allocations to commodity futures as a part of investment policy, but the emperor has no clothes," he said.
"While spot prices have risen since 1970, they have underperformed relative both to the CPI, by a cumulative 21%, and relative to cash, by a cumulative 46% over the last 36 years," the GIS team states in the report.
One economic explanation for this weak historical track record, the GIS team contends, is the rapid pace of technological progress in agriculture and mining and extraction, which causes commodity prices to fall relative to inflation.
UBS Global Asset Management also maintained that the sustainability of commodity futures 'roll returns' - that is, the futures price moves relative to the underlying spot price - is doubtful at best. "For this reason, the 36-year history of commodity futures investing raises serious questions," the report says.
In support of its argument, the GIS team points to high spot prices over the life of the Goldman Sachs Commodity Index, a period between 1970 and 2005 that was influenced by run-ups in the early 1970s and more recently since 2001.
The GIS team noted that during the 27-year period from October 1974 to January 2002, spot prices actually declined at a 2% annual rate. With a roll return just under 2% a year over the period, the total excess return, relative to the cash collateral, was slightly negative, according to the GIS team's research.
"Because the roll return has been positive in the past, many researchers have concocted theories as to why it should be positive in the long run, but none have proved adequately convincing," UBS's Singer said.
In the past, commodity indexes may have been closer to an inflation hedge than any available alternative, according to the GIS team. With the advent of inflation-index bonds and inflation swaps, there now exist much more efficient inflation hedges in most major currencies, maintains the GIS team.
"To confidently allocate passively to commodities, you must be comfortable betting on a spot price gain that occurs once every 36 years or so, and a 'roll return' heavily concentrated in energy and which has been negative over the past 14 years. Simply put, we are not comfortable with such a notion, and we do not advocate allocations to passive commodity investments," Singer concluded.
The views of the Global Investment Solutions team are contained in the latest issue of "Global Perspectives," a quarterly publication of UBS Global Asset Management that uses proprietary valuation models to analyze the financial markets. The document may be found at www.ubs.com/globalam-us.
UBS is one of the world's leading financial firms, serving a discerning global client base. As an organization, it combines financial strength with an international culture that embraces change. As an integrated firm, UBS creates added value for clients by drawing on the combined resources and expertise of all of its businesses.
UBS is the world's largest wealth manager, a top tier investment banking and securities firm, and one of the largest global asset managers. In Switzerland, UBS is the market leader in retail and commercial banking.
UBS is present in all major financial centers worldwide. It has offices in 50 countries, with about 39% of its employees working in the Americas, 37% in Switzerland, 16% in the rest of Europe and 8% in Asia Pacific. UBS's financial businesses employ more than 69,500 people around the world. Its shares are listed on the SWX Swiss Stock Exchange, the New York Stock Exchange (NYSE) and the Tokyo Stock Exchange (TSE).
The views expressed are those of UBS Global Asset Management as of March 21, 2006.
Paul Del Colle
New York , April 4, 2006