In an effort to reduce risk and improve returns of the total investment portfolio, more investors are seeking to invest in alternative investments like commodities. The commodities market covers a broad range of products including raw materials, grains and meat, oil, gas, and precious metals.
Compare to equities, bonds and mutual funds, the complexity and volatility of commodities investing make it the riskiest place to earn a return on your savings.
Investing in commodities is unlike other instruments because it’s more like placing a bet or speculation. You will be pitting your knowledge against experts who make their living in the commodities market.
Characteristics of commodities
While stocks and bonds are referred to as “financial assets,” commodities fall under the alternative investment category called “real assets.”Commodities are subjected to the ever-changing fundamentals of supply or demand and the influences of weather, transportation costs and economic forecasts.
In recent years, commodities prices have trended up due to higher demand, especially from China, India and other developing nations, for raw materials ,including oil, metals and other products.
Many investors add commodities to their portfolios as a “hedge” against inflation. Commodities offer one of the few asset classes that increase in value when inflation put upward pressures on the price of goods and services. Commodities also have lowest correlation to returns of stocks and bonds.
Methods for “investing” in commodities
If you decide to invest in commodities, make sure you have an established plan. Many investors gain asset to the commodities asset class by purchasing futures contracts on regulated futures exchange. The process involves the trading of futures contracts—an agreement to buy or sell a commodity at an agreed upon price by a specific date.
The investor must settle the account by a certain date or risk taking physical delivery. Like stocks, commodity prices change from minute-to-minute. The biggest volume of commodity trading occurs in gold, oil and agricultural products.Investors who would like to add commodities to their portfolio without dealing with futures contracts can consider the following funds:
- Commodity mutual funds – A few mutual funds invest directly in commodities. Others invest in companies that process commodities. Funds that try to mirror the performance of different commodity benchmarks provide another option.
- Exchange traded funds (ETFs) – These privately operated funds are traded on public exchanges—the same as stocks. Some ETFs track the performance of commodity-related assets, such as crude oil, gold and silver or the performance of commodity indexes. Other funds may invest in commodities futures or use a combination of both investment strategies.
- Commodity Index funds- This instrument consists of a fixed-weight index, which is an average of certain commodity prices based on spot or future prices. The index represents a particular commodity asset class or a subset of commodities like metals or energy.
Most experts recommend that small investors limit their commodities investing strategies to ETFs, stocks of commodity-producing firms or mutual funds that invest in a broad range of commodity assets.