A commodity is a physical asset, such as gold, silver, wheat and oil. Investing in commodities is different from investing in stocks and bonds because commodities respond to economic events differently than companies offering goods and services. Commodity investments offer some attractive advantages to investors.
When mixed with classic asset classes, such as stocks and bonds, commodity investments offer investors an even greater amount of diversification than a portfolio without commodities. Commodities typically experience a low or negative correlation to stocks. This means that commodities and common stocks do not move as drastically, or necessarily in the same direction when events in the financial markets occur.
Hedge Against Inflation
Commodity investments often serve as a hedge against inflation, which is advantageous for investors. According to Gary Gordon of the Wharton School of Business, a positive correlation exists between commodity futures and inflation. In other words, when inflation rises, the value of commodities also increases. Commodities are goods that work to drive up the cost of inflation. For example, when the United States economy is an inflationary period, the value of the dollar decreases, which causes the price of gold to increase. Inflation also causes an increase in the prices of commodities, such as coffee, corn and rice. As the prices of these goods increase, the value of commodity investments backing these goods also increases.
Good Investments in Bad Economy
Even in a weak economy, consumers still buy commodities. For example, consumers still drive their cars and use natural gas to heat their homes. Consumers typically reduce their use of commodities after cutting back on other discretionary items, such as entertainment and eating out. Therefore, commodities do not only hedge against inflation but typically make good investments in a weakened economy because of constant consumer demand. You can experience a positive return in your investment portfolio or minimize you losses by investing in commodities as well as other asset classes.
Diversity of Asset Types
An advantage of investing in commodities is the ability to choose from a variety of assets. Investors can buy the actual commodity or invest in commodity future contracts, option contracts, mutual funds or exchange traded funds (ETFs). The diversity of asset types allows small and large investors to benefit from commodities. When an investor buys a commodity future or option contract, the investor is speculating on the price of a commodity at a future date. Depending on the investor's position, money is made when the price of the commodity goes up or down. Commodity mutual funds and ETFs invest in a variety of commodities or companies that deal in commodities.
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