UBS: commodities “inexact and unstable” inflation hedge

FWR Staff

11 April 2006

Report challenges conventional wisdom, citing commodities’ underperformance, volatility. Although indexing to commodities may have proved an effective hedge against inflation in past cycles, a new report out of UBS Global Asset Management suggests this strategy may no longer do the trick.

“Commodities are a very inexact and unstable inflation hedge,” says Brian Singer, regional investment officer for the Americans and head of global investment solutions for UBS. “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.”

Since 2001, commodity prices have risen by 150%, but they have underperformed relative to the Consumer price Index by a cumulative 21% – and, relative to cash, by 46% – over the last 36 years.

The report says this – that as technology in agriculture and metallurgy progresses, commodity prices fall relative to inflation. In comparison, instruments such as inflation-index bonds and inflation swaps may form much more effective inflation hedges.

“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,” said Singer. “Simply put, we are not comfortable with such a notion, and we do not advocate allocations to passive commodity investments.” –FWR