Commodities get a lot of attention from the media. The price of oil, gold, corn, soy and hogs are in the national news nearly every day. While investing in the commodities markets is a fairly sophisticated endeavor, commodity mutual funds provide an opportunity for almost any investor to get a piece of the action.
A Variety of Fund Types
The generic label "commodity fund" actually captures several distinct types of investments. These include:
- Commodity Funds These funds are true commodity funds in that they have direct holdings in commodities. For example, a gold fund that holds gold bullion would be a true commodity fund.
- Commodity Funds That Hold Futures Holding commodity-linked derivative instruments is a much more common mutual fund strategy for investing in the commodities markets. Most investors have no desire to take delivery of hogs, corn, oil, or any other commodity. They want to profit from price changes. Purchasing futures contracts is one way to achieve this objective.
- Natural Resource Funds Funds that invest in companies that are engaged in businesses that operate in commodity-related fields, such as energy, mining, oil drilling, and agricultural businesses, are often referred to as natural resource funds. While they often hold neither actual commodities nor commodity futures, they provide exposure to the commodities markets by proxy.
- Combination Funds Some funds invest in a combination of actual commodities and commodity futures. Gold funds, for example, may have underlying holdings that include both bullion and futures contracts.
A Variety of Investment Strategies
In addition to a variety of formats, commodity funds also offer a variety of investment strategies, including active management and passive management. Active portfolios buy and sell in an effort to outperform a benchmark index. Passive portfolios seek to replicate a benchmark index and match its performance. Passive strategies can be implemented using index funds or exchange-traded funds (ETFs).
Pros and Cons of Investing in Commodity Funds
Commodities offer portfolio diversification. Investing in futures contracts or actual commodities provides a portfolio component that is not a traditional stock, bond, or a mutual fund that invests in stocks and/or bonds. Historically, commodities have had a low correlation to traditional equity markets, meaning that they do not always fluctuate in tandem with market movements. For many investors, achieving this low correlation is the primary objective when seeking to add diversification to a portfolio.
Commodities also offer upside potential. The raw materials used in construction, agriculture and many other industries are subject to the laws of supply and demand. When demand rises, prices generally follow, resulting in a profit for investors.
Finally, commodities offer a hedge against inflation.
On the Other Hand
The commodities markets can be volatile and subject to wild, short-term price swings and long lulls. Over the course of just a few days, prices can go from record highs to record lows. For a closer look at the range of price movements, research the price of gold over the past 30 years and the price of copper in 2008.
Another item of note is the composition of various mutual funds and the benchmark indexes that they track. In many commodities indexes, energy is often the heavyweight, taking up more than half of the index. When a mutual fund seeks to directly replicate the index, more than half of the fund's assets will be in energy. Some funds place limits on the percent of the portfolio invested in a single commodity to avoid an over-concentration in a single investment.
Look Before You Leap
While commodities provide access to some interesting investments and strategies, the commodities markets are complex, and not as familiar to most investors as the stock market or bond market. Before you invest in commodities funds, read the fund's prospectus and annual report, and be sure that you understand what you are buying and the role it plays in your portfolio. Likewise, pay attention to the fund's holdings. Make sure that you are aware of how much of the fund's assets are weighted to a particular market sector and plan accordingly for other parts of your portfolio. Keep in mind the volatile nature of the commodities markets and limit holdings to a small percentage of your total portfolio.
FAQs
Investing in commodities can provide investors with diversification, a hedge against inflation, and excess positive returns. Investors may experience volatility when their investments track a single commodity or one sector of the economy. Supply, demand, and geopolitics all affect commodity prices.
How to invest in commodities for beginners? ›
How to invest in commodities
- Physical ownership. This is the most basic way to invest in commodities. ...
- Futures contracts. ...
- Individual securities. ...
- Mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs). ...
- Alternative investments.
Commodity funds invest in raw materials or primary agricultural products, known as commodities. These funds invest in precious metals, such as gold and silver, energy resources, such as oil and natural gas, and agricultural goods, such as wheat.
How much should I allocate to commodities? ›
The diversification-based analysis gave a target between 4% to 9% allocation to commodities from a traditional 60/40 portfolio. Our inflation-based studies indicate 6.7% commodities allocation to attain inflation-hedging characteristics.
What are the top 3 commodities to invest in? ›
You can invest in commodities in a range of ways. Today, the top three in the list of commodities are crude oil, gold and base metals. It is worth taking a look at all three and finding out how to invest.
Which commodity is best for beginners? ›
1. Metal commodities: Metals like iron, copper, aluminium, nickel are used in construction and manufacturing, while platinum, silver and gold are used for jewellery-making and investment purposes.
How do you profit from commodities? ›
Traders make money by buying commodities (or commodity derivatives) for a certain price and then subsequently selling them for a higher price. The buyer of a futures contract makes money if the future market price of the commodity exceeds the market price of the commodity at the time of purchase.
What are the disadvantages of commodities? ›
High Risk: Commodity futures trading can be exceptionally risky due to the potential for substantial price fluctuations. Losses can exceed the initial investment.
How risky are commodity funds? ›
Uncontrollable factors such as inflation, weather, political unrest, foreign events, new technologies and even rumors can have devastating consequences to the price of a commodity. Investors investing in commodities must be able to bear a total loss of their investment.
What are 4 examples of commodity money? ›
Historically, examples of commodity money include gold, silver, tea, alcohol, and seashells. Even if no one would accept such goods as trade, the owners could still use them for their purposes.
Some commodity stocks pay dividends, but not all do. The best dividend stocks don't necessarily pay the highest dividends, but commodity companies with a history of paying reliable dividends and strong financial fundamentals may be worth investigating if you're looking for commodities exposure.
Are commodities riskier than stocks? ›
Because the supply and demand characteristics change frequently, volatility in commodities tends to be higher than for stocks, bonds, and other types of assets. Some commodities show more stability than others, such as gold, which also serves as a reserve asset for central banks to buffer against volatility.
Is it worth it to invest in commodities? ›
Benefits of commodities
This means that when other investments decline, commodities may provide a cushion against losses. Secondly, commodities have the potential to act as a hedge against inflation. As prices rise, the value of commodities often increases, providing a valuable store of wealth.
Is now a good time to invest in commodities? ›
Given that inflation remains stubbornly high in today's environment, “markets today offer a good opportunity to add some commodity exposure,” says Eric Freedman, chief investment officer, U.S. Bank Wealth Management.
What are the risks of commodity funds? ›
Uncontrollable factors such as inflation, weather, political unrest, foreign events, new technologies and even rumors can have devastating consequences to the price of a commodity. Investors investing in commodities must be able to bear a total loss of their investment. Speculative risks.
Is it better to invest in stocks or commodities? ›
Because the supply and demand characteristics change frequently, volatility in commodities tends to be higher than for stocks, bonds, and other types of assets. Some commodities show more stability than others, such as gold, which also serves as a reserve asset for central banks to buffer against volatility.
Is it good time to invest in commodities? ›
Commodities stand to benefit from underinvestment and the clean energy transition. PIMCO has a positive outlook for commodities based on supply constraints, the transition to a net-zero economy, and their historical correlation with inflation.
Which commodity fund is best? ›
Best Commodity Mutual Funds in India in 2022
| Funds | NAV (Rs) | 3 Year Cagr (%) |
|---|
| Aditya Birla Sun Life Commodities Equities Fund Global Agri Plan-Growth | 35.3 | 13.58% |
| Axis Gold Fund- Growth | 16.27 | 9.02% |
| DSP Natural Resources and New Energy Fund - Growth | 53.14 | 17.57% |
| Tata Resources Energy Fund Direct-Growth | 30.34 | 25.87% |
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