Roger Gibson, CFA, CFP, is the president of Gibson Capital Management, based in Pittsburgh. He is also the author of “Asset Allocation: Balancing Financial Risk,” a best-selling book that provides strategies for selecting the right mix of investments to achieve a superior rate of return while at the same time managing risk. This article is adapted from his exclusive webcast, “The Role of Commodities,” for U.S. Global Investors.

Physical commodities are either pulled out of the ground or grown on top of it. Each year there is more than $1 trillion in global production in these areas. Here are the five major commodity groups, with examples of each:

Energy:	Crude oil, unleaded gasoline, natural gas, heating oil.
Agricultural Products:	Wheat, corn, soybeans, cotton, sugar, coffee.
Industrial Metals:	Aluminum, copper, nickel, zinc.
Livestock:	Live cattle, lean hogs.
Precious Metals:	Gold, silver.

There are a variety of ways to invest in these commodities. You might think about owning them physically, but that’s both expensive and impractical.

Another possibility would be to own shares of commodity producers. If you are interested in energy, for example, you could always choose to own oil-company stocks. The share prices of commodity producers, however, do not behave like the underlying commodities because they are impacted by other market factors.

There are also actively managed commodity pools. These investments are generally expensive, returns are dependent on the manager’s skill, and the results do not necessarily reflect the returns in the commodity markets.

A remaining alternative is index investing at an asset-class level. The Goldman Sachs Commodity Index and the Dow Jones AIG Commodity Index both provide continuous exposure to physical commodities through derivatives. The GSCI is a weighted index of global production in those five commodity groups. Seventy percent of the market value of those five groups is energy, so the GSCI is heavily tilted toward energy.

Whereas a more traditional portfolio strategy might focus on U.S. stocks, bonds, and cash, I focus on four equity asset classes: U.S. stocks, non-US stocks, real estate and commodities. This big-picture approach is not dependent upon superior skill, either in selection of securities or market findings.

The chart “Fifteen Equity Portfolios” illustrates more than three decades of performance for equity portfolios that feature different combinations of these four asset classes. The vertical axis shows compound annual return for each portfolio, while the horizontal axis shows volatility as measured by standard deviation.

The four asset classes, each assigned a letter, are represented by respected indexes: (A) the S&P 500 Index for U.S. stocks; (B) the Morgan Stanley Capital International EAFE Index for non-U.S. stocks; (C) the National Association of Real Estate Investment Trusts Equity REIT Index for real estate; and (D) the GSCI for commodities.

The blue squares show returns of each of the four equity asset classes on its own. The annual returns are within roughly 2 percent of one another over this 34-year period and they vary considerably in terms of standard deviation. The least risky alternative is real estate securities and the most volatile are commodities, with a standard deviation of almost 25 percent.