SHOULD I INVEST IN COMMODITIES?

By on Oct 29, 2012 in Advanced Investing, Investing, Mutual Funds | 18 comments

What are Commodities?

commodities investing

INVEST IN COMMODITIES?

A commodity is a good used in manufacturing and commerce. It is indistinguishable from other commodities of the same type. Unlike stocks and bonds which are intangible financial assets, commodities are tangible resources such as gold, copper, steel, wheat, beef, natural gas, and coffee. Although traditionally traded in the futures market, average investors can invest through mutual funds and exchange traded fund (ETFs).

There’s a lot of chatter about investing in commodities because there was a big run up in price over the last year from April, 2011 to April, 2012. Investors see price increases and want to get in on the action. Understand that commodity prices are driven by supply and demand. The rapid world wide growth, especially in China has propelled commodity prices upward. It’s unlikely that the growth in China will continue at the stratospheric paces of the recent past.

commodities returns

5 YEAR COMMODITIES INDEX PRICE CHART (UCD)

The easiest way to invest in commodities is buying shares in mutual fund such as Pimco Commodity Real Return Strategy fund (PCRAX). Of course there are many varieties of broad commodity index funds and funds specializing in specific individual commodities.

Why do People Invest in Commodities?

There is a low correlation between stocks, bonds, and commodities. In other words, they provide diversification and can limit portfolio volatility. Some investors look for opportunities to “beat the market” and like to jump on trends.

Are Commodities a Good Place to Put My Money?

Investors believe that investing in commodities will protect their portfolios against losses if inflation kicks in. Recent gains in commodity prices are due to growth in developing markets such as China, India, Russia and Brazil. Add the inflationary money creation in the US and Europe and commodity prices have trended upwards over the last decade.

Investors who did not invest directly in commodity funds may be sitting on the sidelines wondering if they missed a wonderful investment opportunity and be tempted to jump on the commodity investing bandwagon. You may be surprised to realize that if you own a diversified stock portfolio, you already have exposure to commodities. And the recent stock gains in your diversified index fund include benefits from the price increases in commodity pricing.

Jeff Weniger at Harris Private Bank answers this question in  Money Magazine, September, 2012, “The Secular Bull Market in Commodities is Done”;  What about now, is it a good idea to invest in commodities? Global economic growth is slowing. China may never return to it’s extraordinary growth of recent past. In spite of rising oil and corn prices, most commodities are down in price from their recent peaks.

The Takeaway

Trend chasing is risky business. Trying to predict the future direction of asset classes, based on the past is a fool’s errand. As demonstrated in the price chart, commodities are very volatile with rapid up and downswings. The time tested wealth building strategy is to select an asset allocation in line with your risk tolerance. More stock investments if you can handle greater risk, more cash and bond investments if not. Populate the portfolio with low cost index funds and rebalance once or twice per year.

Be prepared for the total value of your investment portfolio to bounce around a bit. But, if you believe in future economic growth, then hold a diversified portfolio of index funds and over time you will build wealth.

Can’t stay away from dipping into commodities, even though they’ve peaked in 2011?  Allocate a small percent of your investable assets and be prepared for a bumpy ride.

Can’t Get Enough Commodities?

A Beginner’s Guide to Commodity Trading at One Cent at a Time

What is a Commodity ETF and Why do They Stink? at Wealth Pilgrim

How to Invest in Commodities and Why at Moolanomy

What are Alternative Investments at Planting Money Seeds

Have you ever invested in commodities or alternative investments?

caveat; This is not a recommendation to buy or sell any asset. I have never invested in commodities funds and do not intend to do so in the future.

image credit; google images from munkee commodities

    18 Comments

  1. I’ve liked investing in natural resources before. Commodities as an asset class, I agree, are a round place to be. If you like fastening your money to a roller coaster, it can be a fun ride.

    AverageJoe

    October 29, 2012

  2. I never invested in commodities in the stock market. I have some items which may be considered commodities. Things that are sterling silver, gold jewelry and the rest are collectables. Some sectors are more sensitive to commodity prices than others such as food, agriculture, oil and consumables.

    krantcents

    October 29, 2012

  3. @ Joe and @ Krant- You really need a certain mindset to diversify into commodities. Most diversified investors already have commodity exposure through their large multinational companies.

    Barb

    October 29, 2012

  4. Agree Barb. I believe in asset allocation and both commodities and natural resources funds are part of many client portfolios. I often use the PIMco fund you mentioned, I would urge your readers to invest in the lowest cost share class of the fund available to them. I am usually able to get clients into the institutional share class PCRIX, much lower expense ratio.

    Roger Wohlner

    October 29, 2012

  5. I have invested in future commodities before talk about a rollercoaster =) It definitely has to do with supply and demand but keep in mind with all the money printing around the world it has been argued that over time all commodity prices will rise.

  6. @Roger, Excellent recommendation for those folks interested in specific commodity exposure. Always look at fees!!! Remember, your returns don’t begin until after fund fees are paid!
    @Brick by Brick-I think long term that may be one of the biggest positives for investing in commodities.

    Barb

    October 29, 2012

  7. This is what I have been thinking about lately and I was still unsure about the right steps I have to take if I have to invest in commodities. You have enlightened me a lot.

    Riley Emmerson

    October 30, 2012

  8. Barb – you make a great point about how people have exposure to commodities through other investments. In general, I tend to think that a diversified portfolio anchored by index funds is a good way to go, similar to what you’re saying.

    Squirrelers

    October 30, 2012

  9. My husband and I were discussing about portfolio diversity last week and I was suggesting of investing in commodities. This post is a big help in our decision-making. Thanks for your input!

  10. @Squirrelers, It seems like many want to “find the secret” investment to get rich. That secret is basic diversification in the standard asset classes. You don’t need to veer into esoteric investments to build wealth.
    @Cherleen- Glad to help out.

    Barb

    October 31, 2012

  11. I have very small % of portfolio in a natural gas utility single stock and it has only grown and pays nice dividend. I’ve paired this down through the years and socked it away in our ROTH since I don’t like the risks of single stocks.

    Brent Pittman

    November 2, 2012

  12. Commodities seem like a good hedge against inflation. Companies involved in oil and gas exploration and development’ gold mining companies’ copper silver mining companies’ along with companies involved in rare earth minerals. The Best way to go in my view would be a exchange traded fund or a closed end fund that specializes in a broad selection of commodites related stocks. Look for a fund that has very broad exposure to commodities stocks’ not just gold and silver mining stocks but also companies involved in some Basic metals and materials like steel aluminum cement. Some companies involved in rare earth minerials. Also look for some exposure to farming related commodities stocks and some energy related stocks. Look for companies involved in mining precious gemstones like diamonds. Water related stocks like water utilities or companies that perform desalination or water purication. Since nobody really knows which type of commodities and commodities related stocks are going to perform the best or worst. Yor best owning as broadly a diversified portfolio as possible.

    Financial Directory

    November 2, 2012

  13. @Financial- Just a word of caution. Be ready for a lot of volatility if you invest directly in commodity funds.

    Barb

    November 2, 2012

  14. @ Brent- Good move. Diversification is the only solution to market risk and you can’t avoid the risk inherent in individual stocks.

    Barb

    November 2, 2012

  15. I think commodities are in a longterm bullmarket, but with a lot of bumps along the way. One must avoid those bumps. When investing in commodities, timing is key!!

    CFD

    January 26, 2013

  16. @CFD, Commodities are best left to the more sophisticated investors.

    Barb

    January 27, 2013

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