What are commodities? Commodities are basic goods, which are often used as inputs in the production of other goods and services. Overall, there are 4 kinds of commodities: Metals, Livestock & Meat, Energy, and Agriculture. Gold, silver, copper, hogs, live cattle, feeder cattle, crude oil, natural gas, gasoline, coffee, cotton, sugar, corn, wheat, rice are all examples of commodities. In this week’s blog post, I will talk about whether or not you should include commodities in your portfolio.
Similar to stocks and bonds, commodities can also be an allocation in your portfolio. In fact, certain commodities can be a great hedge against both stocks and bonds. Said differently, commodities come to your rescue when the stock market is falling and inflation is rising rapidly. When inflation is rising, fixed income investments such as bonds are no good because by the time your 30 year bond is going to mature, that $1000 investment is going to be worthless. One exception is investing in Treasury Inflation-Protected Securities (TIPS), which has some tax consequences when the par value is adjusted to account for inflation. One needs to pay taxes on the adjusted par value before he/she even materializes the profit. So, unless you have TIPS in your retirement account, it might not be that great of an investment during inflationary environment. Now, how do commodities protect an investor against inflation?
A lot of investors prefer having gold (commodity) in their portfolio as a hedge against both inflation and stock market crash. Investors understand that the Federal Reserve could print money, and make the dollar worthless. However, there is a finite amount of gold in the world, so gold will hold its value even during an inflationary environment, when the value of a currency becomes worthless. Additionally, investors flock to precious metals when there is volatility in the market. Commodities are driven by supply and demand. In other words, lower supply drives up demand, which results in higher prices. Similarly, higher supply drives down demand, which results in a price drop. This is precisely what makes commodities speculative. Since supply (production) and demand (consumption) is constantly changing, the equilibrium “price” is constantly changing as well. For instance, wheat prices are expected to rise because 2020 is supposed to have an extremely dry and hot beginning, followed by massive flooding later in the year – this would mean crop failure i.e. a drop in production, which would lead to an increase in price.
It is important to note that, unlike stocks, commodities are not operating businesses generating profits and dividends. In fact, the fees to invest in commodities ETF is usually more than investing in the S&P 500 index ETF. Ray Dalio, the billionaire value investor, talks about the importance of having commodities in your portfolio. Dalio’s all-weather portfolio allocated 7.5% in gold, 7.5% in commodities, and the rest in stocks and bonds. In contrast, billionaire Warren Buffett does not like investing in gold because it is not a productive asset. So, should you have exposure to commodities in your portfolio? Any professional investor will tell you that it is crucial to have a balanced portfolio. One of the prudent ways to bring balance to your portfolio is by investing in commodities.
An easy way to gain exposure to commodities is via ETFs or ETPs. Please look at the net expense ratios of commodity ETFs/ETPs as some of them can have astronomically high expenses. Here are some of the examples of commodity ETFs/ETPs:
- Invesco DB Agriculture Fund (DBA)
- iShares Gold Trust (IAU)
- Aberdeen Standard Physical Silver Shares ETF (SIVR)
- Teucrium Wheat (WEAT)
- United States Oil Fund (USO)
Hope you learned a little and found this blog post helpful. We talked what commodities are, examples of different commodities, and how commodities bring balance to your portfolio. As always, you can sign up for our free mailing list here. You can sign up for our paid subscription services here. Like us on our Facebook page here. Thank you!
Superior North LLC’s content is for educational purposes only. The calculators, videos, recommendations, and general investment ideas are not to be actioned with real money. Vyom Joshi is not a professional money manager or a financial advisor. Contact a professional and certified financial advisor before making any financial decisions. Please review the Disclaimer and Terms and Conditions.