trading/investing in commodities - why do/have people prefer equities?

[NajdorfDefense]

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Individual stocks have the same expectation as index funds, but lower variance.

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This is of course, untrue, in a variety of ways.

[fun160]

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Commodities don't earn dividends, i.e., when you're holding it, it's just sitting there not doing anything.

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Not exactly true. You only need to put up a few percent margin to purchase a commodity futures contract. The rest can be invested in interest-bearing instruments. (T-bills being the instrument of choice for most futures traders.) The interest income can be thought of as a type of dividend.

[fun160]

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Individual stocks have the same expectation as index funds, but lower variance.

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What in the world are you talking about? I can find hundreds (thousands?) of stocks whose implied and historical volatility (over whatever time frame you choose) is greater than that of the S&P 500 Index.

[fun160]

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Just wondering why so many people go for equities? The recent last few years for commodities seems to of been great, why have so many not taken advantage?

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One of the biggest reasons is liquidity. The biggest funds need to purchase a whole bunch of whatever to have a meaningful impact on their portfolio. So they need to be in a market that's deep enough to afford them the liquidity to buy and sell without having overly dramatic market impact. That greatly limits the sandboxes in which they can play. Large-cap stocks, debt, currencies...

Crude oil is one of the few commodities that's deep and liquid enough for very large traders to accumulate without paying up too much due to the price impact of their buying.

If a small trader wants to buy a handful of O.J. or pork belly contracts, no problem. But if a major fund wanted to buy 10K contracts--yikes!--the average price would be very, very ugly.

[kimchi]

Commodities can be very profitable and deserve a place in any diversified portfolio. Most people see them as higher risk and more volatile. They are not. Only the mis-use of their leverage makes them appear more risky.

Many commodity contracts are less risky than individual stocks (pound for pound). You just need to employ proper money management and position sizing relative to your account.

Commodities are better suited to medium/long term trading due to their trendiness. Their is less 'noise' in commodities' prices and the trends are more pure and last longer. This makes them more suitable for a trend-following strategy.

They also are uncorrolated (on the whole) to stocks.

Most people however, don't have an account large enough in which to safely trade/invest in commodities. That's why so many people go bust trading them.

[Tupacia]

gull - No. What conceivable reason can you think of as to why a basket of stocks will have more variance than individual stocks? Hint: there is no reason because it is untrue.

[pig4bill]

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thanks for all the replies.

the general consensus seems equities are a wiser investment becuase of their historical greater growth.

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I didn't see that as a consensus at all, just a couple opinions. A statement like that also shows that you do not understand the nature or purpose of futures.

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i understand that, just given the recent huge growths in some commodities, i still fail to understand why people have not invested in them or in resource sector equities.

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What makes you think they haven't?

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my feeling is that those people who are aiming to make big bucks are those going for commodities, and those people looking for a safe 10%-15% long term (10 years+) return are going for equities.

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You keep saying commodities. Do you mean futures? Or do you think people keep drums of oil in their back yards?

[gull]

Sorry about what I said above.

Individual stocks obviously have higher variance than index funds. When writing the post, I edited my sentence to clear up pronoun confusion later, but missed fixing up that part of the sentence. My sentence was clearly but unintentionally false, and also incongruous with the rest of my post. Owning more stocks will diversify risk and reduce variance.

[fun160]

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You keep saying commodities. Do you mean futures? Or do you think people keep drums of oil in their back yards?

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There are other futures besides commodity futures, including those on stock indices, debt instruments, and foreign currencies.

Moreover, one can own phyical crude oil (or soybeans or cattle or coffee) without storing it in the back yard.

[DesertCat]

I think there is a lot of good answers here, but let me add one. Stocks are part ownership in a business, and thus have an intrinsic value based on that business's assets and cash flow. Commodities are only worth what people will pay for them.

You might say well, stocks are only worth what people will pay for them as well, but that's only true in the short run. For example, if you buy a dividend paying stock for $10 because it pays $1 a year in dividends, and because it will safely continue to do so for a long time in the future, it has intrinsic value. If it starts trading at $2, you know it's too cheap, and you can buy more or ride it out continuing to earn 10% a year on your original investment. Any business that has enough cash flow to keep paying a $1 dividend is worth much more than $2 per share and the market will soon correct that price. If not, the company can jump in and buy back shares to help the market "recognize" it's mistake.

If you buy silver at $10 and it starts trading at $2, you don't know where it is going next. You have no dividends to support the value of your investment, and your silver has no cash flow to buy more silver with when it gets too cheap.

This is the simplistic argument, obv. intrinsic value is dependent on total company cash flow and how well management distributes/reinvests it. I.e. a company with no assets & profits, or being run by a management team that takes all profits before they reach shareholders has no intrinsic value and trades like a commodity.

The other argument against commodities is the Julian Simon argument, that over long periods commodities always get cheaper, when measured in relation to income levels. I don't know if that means matching inflation as previously asserted on this thread, but it's similar enough to make sense. Essentially if commodities grow at 3% per year (the inflation rate) they'll cost the same every year. But if the stock market grows at 8% per year, it takes less shares of stock to buy commodities over time.

John Bogle was just quoted as saying commodities are useful only for speculation, and that's a reasonable opinion. Commodities are there to help you either get richer at a faster rate, or help you go broke at a faster rate, than the stock market typically operates at.