Investing in commodities like gold, oil, and corn offers many advantages. Commodities allow investors to diversify away from tech stocks or other trendy assets. Commodities are barely correlated with traditional assets.
If you want to instill some welcome freshness and diversity to your investment portfolio while limiting its volatility, commodities may be the answer.
In addition to limiting portfolio volatility, commodities offer investors a couple of more tangible advantages.
Commodities limit exposure to inflation. The price of commodities tends to follow inflation. If you have your money in gold or oil, you worry less about it melting away under the pressure of monetary manipulation.
You can buy physical commodities and use them as stores of value. Tangible assets like gold bullion can give literal weight to your portfolio.
The factors that determine the price of commodities are supply, demand, and various geopolitical and economic considerations.
How Can You Invest in Commodities?
The markets offer investors many ways to gain exposure to commodities and commodity prices.
- The most rudimentary way of investing in commodities is to acquire physical assets. For the majority of investors, this approach is only viable with commodities that don’t take up much space and are easier to handle, like gold bullion. Few people can afford to take physical reception of thousands of barrels of crude oil.
- Most investors trade commodities via futures contracts. Futures contracts are practical, which is why investors prefer them to other commodity investment methods. Although they carry risks, and it is possible to lose money on commodity futures contracts, they act as solid hedges against volatility in traditional stocks due to their non-correlated nature. Traders can access commodity futures contracts at a fraction of their value. And that also plays into their attractiveness.
- Stocks of commodity-producing companies give investors exposure to commodities without requiring them to trade or hold goods directly. The stock price of a commodity-producing organization is closely correlated with the price of the commodity it produces.
- ETFs (exchange-traded funds) and mutual funds allow investors to gain a balanced exposure to commodities for affordable investment minimums.
- Private investments and hedge funds. Investors who don’t mind higher volatility and risk may want to invest in commodities through alternative methods. Such methods are riskier, and though they may offer higher potential returns, they may not be the best option to invest in commodities.
The Risks of Investing in Commodities
Lopsided commodity investments will not work for diversification. They don’t protect investors against unforeseen economic events and price swings. Investors may put a large part of their portfolio into a single commodity. This way, they expose their portfolio to the price swings of that particular asset.
- Principal risk is always a factor in commodity investing. Commodity prices are volatile and subject to the whims of regulators, government policymakers, geopolitical events, and currency stability. Investing in commodities does not guarantee that your investment won’t result in a loss.
- Volatility can sneak into ETF-based investments. When they track a single economic sector, ETFs do not protect against price swings and sustained loss of investment value.
- Commodity funds may not function well as a hedge against volatility. These funds often limit their exposure to one or two industries. Thus, instead of diversifying a portfolio, commodity funds may concentrate assets.
- Commodity stock funds may engage in risky investment strategies. Investors using such funds to gain exposure to a given commodity may find that their investment vehicle fails to follow the price fluctuations of the underlying commodity.
- Emerging markets are high-risk high-volatility markets. And many commodities depend directly or indirectly on such markets. Political or economic instability in a country somewhere may trigger unexpected commodity price swings. Even the foreign currency markets may have an impact on the performance of commodity investments.
How to Invest in Crude oil and Gold?
The most straightforward way for investors to trade oil is through futures. Futures trading requires expertise and advanced knowledge, however, so it is not suitable for beginner investors.
An easier way to gain exposure to oil is to invest in oil company stocks or energy ETFs. Mutual funds or ETFs with exposure to oil companies are also options to consider.
More reading: Invest in Oil
Gold bullion or coins are relatively easy to handle and store. Investors can buy physical gold in these forms and pay for safe storage. They can also invest in gold mining stocks and ETFs, as they would if they were interested in oil investments.
More reading: Invest in Gold
Commodities carry specific risks, but they provide a way for investors to diversify their portfolios. Understanding how the commodity markets work is a must before investing.