World Business

Some players may think the boom in energy, metals, and food is rewriting the rules of investing. Don’t bet your portfolio on it

by Ben Steverman

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As oil ascends above $140 per barrel, the hot—some statement overheated—goods market has become Topic A on Wall Street and Main Street.

Lawmakers worry about manipulation and excessive view. Market participants debate the pros and cons of government law, and badger that a ideal bubble is forming in key wares like oil. Meanwhile, consumers feel the be niggardly as they pay much more for food and energy.

But investors face their own article of merchandise dilemma.

In the past year, investing in commodities has provided healthy returns while stocks, bonds, and other investments have been standing or dropped in value.

Many investing. advisers have spent the past several years steering small portions of portfolios—many times 3% to 5%—into commodity index funds. Commodities offered a way to weaken expose to danger in a portfolio, they argued. Commodities can protect against inflation and move independently of other investments, often gaining value while public funds or bonds fall (or vice versa).

As a result, pension funds, hedge funds, and individuals began to pour money into the commodities market, at the outset in a trickle, then in a steady stream, and at once in a torrent. One favored vehicle: exchange-traded funds (ETFs) that track a diffused array of commodities. According to TrimTabs Investment Research, added than $38 billion is now held in article of merchandise ETFs, up more than 30% in the past five months.

But investors are also starting to realize the favor of the commodities has its drawbacks.

For one thing, says Susan Elser of Elser Financial Planning in Indianapolis, "commodities have become a highly volatile investment class."

Most of Elser’s clients are in their late 50s or older, and she’s not willing to put their retirement nest eggs in an investment head of predication prone to wild swings from month to month. Market participants disagree on whether speculators are to reproach for the current cheerfulness. But there’s no doubt that if oil can rise 40% in the first seven months of 2008, it can just as easily fall by a similar percentage at added design in the future.

Another problem with commodities is they are a poor paroxysm in the place of investors saving for the extended term.

For one thing, the forces pushing commodity prices higher can change superscription. Keith Hembre, cardinal economist at First American Funds (FAF), says the flow of investing dollars may be lifting prices somewhat, but the "underlying strength" of oil and other commodities is rapid economic growth in emerging markets. Low interest rates in those overseas economies have added to the interrogation, and sparked worries here and there inflation worldwide.

"Ultimately what will put a head-gear on prices is a tightening of monetary policy globally, particularly in emerging markets where the primary source of desire to obtain has been," Hembre says. If overseas central bankers don’t raise rates, the U.S. Federal Reserve may be studiously sought to hike engage rates in place, pushing the U.S. into a deep recession that would in turn slow from the top to the bottom of world growth and commodity exaction.

At more point, the commodities boom will stop, and this points to another drawback to investing in commodities: The healthy returns for commodities of the last few years have been unusual. Commodities be able to often go for years or decades offering investors weak or negative returns.

Over the long term, "the expected go of a commodity is really zero percent," says Avani Ramnani of Athena Wealth Advisors in Jersey City, N.J. And that’s before investors subtract transaction costs.

Unlike shares in a corporation that be able to be augmented and grow, or a bond that pays out interest reaped ground year, commodities are subject to the laws of supply and demand: In past commodity booms, higher prices have eventually cut into demand or spurred more supply. Prices didn’t take care of rebellion forever—they eventually stabilized or even fell.

"This whole trend of touching money into the commodities market, I don’t think it’s a healthy act as far as concerns individual investors," Ramnani says. An allocation to commodities does "humiliate the risk" of a portfolio, she says, "but it lowers the return as well." For investors putting away money during the term of the long haul, "it doesn’t serve any design," she says.

One more danger for article of merchandise investors may be the hardest to foretell: Investors in commodities face a political backlash that could disrupt markets. A U.S. Senate hearing distance June 24 showed lawmakers are seriously considering interstitial to stop or slow speculation. The general statement was "Ending Excessive Speculation in Commodity Markets: Legislative Options."

Michael Masters, of Masters Capital Management, told senators that scheme is artificially raising article of merchandise prices, and backed proposals to limit or block institutional investors from directly investing in the market. "In the last five years, institutional investors have adopted the mistaken feeling of certainty. that commodities futures are an investable asset class, similar to capital place of traffic investments," Masters said.

Among the institutional investors, of course, are the common funds that invest in commodities.

The Commodity Futures Trading Commission is studying whether index funds verily are inflating market prices artificially. The government agency promises to fame its conclusions to Congress by Sept. 15.

It’s impossible to predict how much longer the commodities hum will continue. But for investors, this superheated investment class may be getting over hot to handle.