Citing a history of underperformance and volatility in commodities, UBS Global Asset Management released a report early this month challenging the commonly held notion that investing in commodities as an asset class provides a reliable hedge against inflation.

The report warns that even though commodity prices are up about 150 percent since the end of 2001, investors should be wary about turning to them as potential investment opportunities. The study also finds that “while spot prices have risen since 1970, they have underperformed relative both to the CPI, by a cumulative 21 percent, and relative to cash, by a cumulative 46 percent over the last 36 years.”

One economic explanation for this weak historical track record, the study 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. 

In support of its argument, the report 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, noting that during the 27-year period from October 1974 to January 2002, spot prices actually declined at a 2 percent annual rate.

With a roll return just under 2 percent a year over the period, the total excess return, relative to the cash collateral, was slightly negative, according to research.

The report also faults researchers who believe that positive roll returns in the past indicate positive returns in the long run, saying that in the past, commodity indices may have been closer to an inflation hedge than any available alternative. The advent of inflation-index bonds and inflation swaps brought much more efficient inflation hedges in most major currencies.