Investing In Commodities: Why?

Commodities are raw materials that are either consumed directly, such as food, or used as building blocks to create other products. They are often overlooked as a component of an investment portfolio, but they can be an important way to diversify beyond traditional securities.

Commodities such as precious metals, oil, and agricultural products have their own highly specific industry conditions, making them attractive for investors looking to diversify their portfolios. They can also act as a hedge against inflation, as their prices tend to rise with it.

There are several ways to invest in commodities, including purchasing physical goods such as gold, buying stocks of commodity-related businesses, or investing in mutual funds or exchange-traded funds (ETFs) that track specific commodity indexes.

However, it's important to note that commodities are considered risky investments due to their volatility and susceptibility to various external factors such as weather, epidemics, and natural or human-made disasters.

Commodities can be a hedge against inflation

Commodities are considered a hedge against inflation because their prices typically rise when inflation is accelerating. As demand for goods and services increases, the price of those goods and services rises, as does the price of the commodities used to produce them. Commodities are one of the few asset classes that tend to benefit from rising inflation.

Commodities can be a good investment during inflationary times, along with other asset classes like real-return bonds, foreign bonds, and real estate. They can provide multiple degrees of downside protection and upside potential.

Gold, in particular, has traditionally been a safe investment and a hedge against inflation. When the US dollar declines, gold prices tend to rise. Other precious metals like silver also trade similarly to gold.

However, it's important to note that commodities tend to be much more volatile than other kinds of investments. They are subject to fluctuations in the market through exchange rates, interest rates, and the global economy.

There are several ways to invest in commodities, including through physical ownership, mutual funds, and alternative investments such as hedge funds. One of the appeals of commodities is the range of products available, such as agriculture, natural resources, precious metals, and livestock.

Commodities can offer portfolio diversification

Commodities tend to have a low correlation with stocks and bonds, which means that in a diversified portfolio, they will not usually move in sync with other asset classes. This tends to reduce the volatility of the overall portfolio, lowering portfolio risk and improving the consistency of returns over time.

Commodities are also affected by different factors to stocks and bonds. For example, commodities are affected by supply and demand dynamics, weather conditions, geopolitical instability, and mining strikes. These factors do not tend to affect stock or bond market returns to the same degree.

However, it is important to note that diversification does not guarantee returns or protect against losses. Commodities can be volatile and may not be suitable for all investors.

Commodities can be physical assets

Gold and silver are two of the best-known commodities used as physical stores of value. Investors can purchase these metals in the form of bullion, which has a value close to the melt price (the market price for the metal if it were melted down).

However, owning precious metals in physical form comes with issues of storage, insurance, and liquidity. Commodities beyond precious metals have even more significant storage issues due to larger quantities and shorter shelf lives. Therefore, most commodities investors do not pursue physical ownership.

Another way to own physical commodities is through ETFs (exchange-traded funds). ETFs provide a convenient way to gain exposure to a commodity or a group of commodities, offering "pure-play" exposure to a commodity along with the simplicity of an ETF.

It is important to note that ETFs that track physical commodities may not always reflect point-for-point changes in the underlying commodity's price. Additionally, these ETFs can be highly volatile due to the volatile nature of commodity prices.

In summary, while commodities can be physical assets, there are practical considerations and challenges associated with physical ownership. ETFs offer a more accessible alternative for investors seeking exposure to physical commodities.

Commodities can minimise portfolio volatility

Commodities can be a great way to minimise portfolio volatility. Here's how:

Commodities have a low historical correlation with traditional assets, such as stocks and bonds. This means that adding commodities to a portfolio of less volatile assets can actually decrease overall portfolio risk. Commodities are appealing to investors looking to diversify their portfolios because their prices often follow inflation and they provide performance that diverges from the stock and bond markets.

Commodities are also influenced by different factors than traditional assets. For example, commodities returns can be affected by weather, politics, or global production. This means that investing in commodities can provide a hedge against other investments. For example, if you own an airline company that is heavily exposed to oil price increases, you can offset that risk by investing in oil.

Another benefit of commodities is that they can be a hedge against inflation. As inflation rises, so do commodity prices, as they are often inputs into manufacturing processes or consumed by households and businesses. Commodities can therefore be a good investment during periods of high inflation.

It's important to note, however, that commodities tend to be much more volatile than other kinds of investments. They can be subject to large price swings due to changes in supply and demand. For example, the COVID-19 pandemic and the war in Ukraine caused major supply disruptions, leading to a sharp rise in the volatility of commodity prices.

Overall, while commodities can help minimise portfolio volatility, it's crucial to understand the risks involved before investing.

Commodities are influenced by supply and demand

Commodities are raw materials or basic goods used in commerce that are interchangeable with other commodities of the same type. They are used as inputs in the production of other goods or services, rather than being finished goods sold to consumers. For example, a barrel of oil is essentially the same product, regardless of the producer.

Commodities are often traded on exchanges, such as the Chicago Mercantile Exchange (CME), the London Metals Exchange, and the Intercontinental Exchange (ICE). On these exchanges, commodities are traded in the cash or spot market, and as futures contracts.

The price of a commodity on an exchange is determined by supply and demand. For example, if the supply of oil increases, the price per barrel decreases. Conversely, if the demand for oil increases, the price rises.

Commodities can be influenced by various factors, including economic shocks, natural disasters, and investor appetite. For example, during times of increasing inflation, investors may flock to commodities as a hedge against a currency's decreased buying power, leading to increased demand and higher prices.

It's important to note that not all commodities are equally influenced by supply and demand. Some commodities, such as gold, are considered safe investments and tend to have higher demand during times of economic uncertainty, leading to price increases.

Overall, understanding the supply-demand situation and its potential impact on commodity prices is crucial for investors looking to invest in commodities.

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