Commodities investments can help diversify your portfolio. They are tangible assets that may respond differently than stocks or bonds to changing economic fundamentals, which are mostly financial assets.
Many investors also view commodities as an effective hedge against inflation, as they typically increase when inflation accelerates.
Investing in Commodities
The commodity market is a physical or virtual space where interested parties exchange goods for cash, such as spot trading or derivative contracts like futures contracts. Prices on commodities are generally determined by economic principles but can also be affected by currency movements, inflation rates and overall supply and demand patterns in various regions around the globe.
Commodity investing can be an excellent way to diversify your portfolio. Studies have revealed that adding commodities can improve performance of stocks and bonds portfolios alike; additionally, commodities can act as an excellent hedge against inflation.
Recently, various investment vehicles that track commodity indexes such as ETFs have emerged to provide investors with exposure to the commodities market without incurring the underlying risks associated with CTA managed futures accounts. Through an overlay strategy these investment vehicles can increase expected return while simultaneously decreasing standard deviation (Bessler & Wolff 2015)–this combination of improved returns and decreased risks is known as Sharpe ratio.
Investing in Commodity Futures
Individuals can invest in physical commodities such as precious metals, grains and energy products like oil, gas or electricity. Additionally, individuals can trade commodity derivatives (commodity futures or ETFs) and mutual funds that track commodity indices like S&P GSCI.
Commodities tend to react to shifting economic fundamentals differently than stocks and bonds, which are considered “financial assets.” Commodity prices generally increase during times of inflation as consumers demand more goods and services made with commodities that must also increase production costs for this increase in consumption.
Commodity futures investments can help investors to reduce portfolio volatility due to their historically low correlation with traditional investments. But investors must keep in mind that futures contracts can be highly unpredictable and may not produce returns over longer timeframes; additionally, margin requirements require that you maintain positions with sufficient funds in your brokerage account.
Investing in Commodity Stocks
Commodity trading presents an array of investment opportunities. Traders can purchase physical commodities like precious metals, natural gas and crude oil via futures contracts or invest directly in individual commodity-linked stocks.
Commodity stocks typically show low correlation to traditional assets, helping reduce portfolio volatility and offering opportunities to leverage investments for high returns – although traders should be mindful of any associated risks when engaging in this form of trading.
Energy commodities like crude oil and natural gas; metals like copper, gold and silver; soft commodities like wheat cocoa coffee and livestock are among the products produced by companies participating in the commodity markets. By investing in stocks produced by these companies that manufacture commodity markets indirectly and profiting from increased demand for them; but prices may fluctuate so investors should research individual stocks carefully before taking positions that exceed margin calls limits.
Investing in Commodity ETFs
Commodity exchange-traded funds (ETFs) give ordinary investors access to commodity markets in an economical, risk-tolerant manner, providing diversification benefits as well as potential inflation protection.
ETFs that invest in derivatives (such as futures contracts) to gain exposure to commodities can be complex and risky investments, potentially underperforming their benchmark index over time due to futures market dynamics such as backwardation or contango.
Investors can gain indirect access to commodity markets by purchasing shares of companies that produce specific commodities. However, this type of investing is subject to global events such as weather and geopolitical conflict that could impact supply and demand, as well as taxed at capital gains rates rather than ordinary income rates. ETNs (exchange-traded notes) offer another way of investing indirectly in commodity markets – these debt instruments issued and backed by banks with maturity dates match returns of assets they support – with capital gains taxes applied at their rate.