4 Points To Understand Commodity Investing

Every once in a while, I get this comment: “Andrew, should I change all my investments to gold?”

Due to election jitters, I’ve been getting this question a lot more these days, and more people are asking about commodity investing (i.e. precious metals, oil, etc.).  Any time people get nervous, this question comes up, as people perceive investing in these types of commodities will lessen their risk during volatile times.

Below are Diversified’ s four talking points on investing in this sector in general.

  1. For starters, commodities are a broad sector. They range from energy, metals, livestock, and crops, to name a few. Generally speaking, individuals add them to a portfolio to hedge against inflation and volatility. They’re hard to access and invest within. One can literally buy a commodity, like gold bars, but that’s challenging to say the least. Another option is buying into the futures market, essentially taking bets where prices will be in the future. An individual can buy index funds or ETFs that mimic a commodity sector, but again that’s risky and volatile. Finally, someone can buy stock in companies that produce said commodity (think Alcoa or Exxon).
  2. Our investment analysis and belief are that commodities can certainly add a diversification benefit and hedge against some inflation. The underlying issue, however, is they’re very volatile, which is the opposite of why most people purchase them. Additionally, the research shows that the addition of commodities to an investment portfolio can actually deteriorate the risk-adjusted rate of return over a long period of time.
  3. Stocks give plenty of a hedge against inflation, while having a better growth capability. On the fixed income side, Treasury Inflation-Protected Securities (TIPS) come with substantially less volatility and provide that very inflation protection many worry about. We prefer these vehicles for investing when it comes to inflation protection over hard commodities.
  4. If you’re hellbent on investing in commodities, doing so through ETFs or commodity-related businesses are the most practical way to go. We do have some exposure to commodity-related business in our models, although we shy away from direct exposure to commodity investing. Typically speaking, we see the best use of investing in commodities and commodity futures as being left to big industry. For instance, airlines may like the price of oil right now and buy a massive amount of oil futures. What this does is lock in their prices for what they’ll pay for oil consumption into the future. The win for them is that they’re making a bet on getting a good price on this commodity and can more easily plan their profit projections. In our minds, that’s the perfect entity who should be buying into the commodity markets, not individual investors.

To make my point…

…what do you think oil has done this year? What if I told you it’s down 33% this year alone (as of 10/15/20)? See what I mean, the juice ain’t worth the squeeze.

Better Ways

In summary, I understand the appeal of investing in commodities. Who doesn’t love gold? Ask Scrooge McDuck from Ducktails; he loved jumping into a room filled with gold coins for a swim. It’s gotta be fun to do, right?

In all seriousness, we think there are better, less risky, and more proven ways to get the benefits you want out of investing in these commodities, without actually investing in them. That’s not to say we won’t see opportunities in the future. If we do, I promise you’ll be the first to know.

Stay wealthy, healthy, and happy everyone!

Related: Markets Hit an All Time High, What Did You Learn?