What are Commodities?

commodities investing

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

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

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