TradingKey - When the stock market plummets by 20%, gold may quietly rise by 15%. Meanwhile, when bond yields remain low, oil prices might soar due to tight supply and demand.
The unique attributes of commodities make them a "natural diversification tool."
What are the methods available for investing in commodities? And how does incorporating commodities into an investment portfolio change risk and value dynamics?
How Can Commodities Be Invested In? What Are Their Advantages and Disadvantages?
If you want to incorporate commodities into a diversified investment portfolio, the first task is to understand the investment avenues for commodities. So, what are the specific ways to invest in commodities?
- Spot Investing
Spot investing involves directly purchasing physical commodities, such as gold bars, silver ingots, or barrels of oil.
The returns primarily come from price appreciation of these commodities, especially during periods of inflation when these tangible assets tend to hold their value well.
However, this investment approach has several obvious drawbacks:
High storage costs need to be considered—this includes warehouse space, preservation conditions, and insurance expenses.
Poor liquidity; physical delivery and transaction processes tend to be relatively complex.
- Futures Investing
Futures investing entails engaging in trading commodity futures contracts within futures markets.
Its main feature is leverage—you only need to pay a small margin to control large contracts.
If your price forecasts are correct, you can achieve returns multiple times greater than your initial investment.
However, using leverage comes with both benefits and risks; if market trends move against your expectations, losses can also be magnified—potentially leading to a total loss of capital.
Additionally, futures contracts demand either the delivery of the commodity itself or the settlement of positions upon expiration.
If an investor misjudges the market and fails to close positions in time as expiration approaches, they may be forced into physical delivery—increasing transaction costs and risks.
(Source: Freepik)
- Commodity ETF Investing
Commodity ETF investing refers to exchange-traded funds that closely track the performance of commodity price indices or related indices.
This investment method resembles stock trading; it can be bought and sold in real time on stock exchanges with relatively low transaction costs—typically around 0.3% to 1% for management fees.
It offers high liquidity for quick buying and selling while allowing investors to capture market opportunities promptly.
The investment threshold is also relatively low; participation can require just hundreds or even tens of dollars, making it very suitable for average investors.
However, ETF returns mainly depend on the performance of the tracked index and may not provide additional returns beyond index performance.
Due to management fees, methods for index replication, etc., there may be discrepancies between the fund's net asset value and the benchmark index it tracks.
- Investing in Commodity-Related Stocks
Investing in commodity-related stocks involves selecting shares of companies closely tied to commodities, such as those in the oil extraction and mining sectors.
When commodity prices rise, these companies' profitability typically increases, which can lead to a rise in their stock prices—providing you with both capital appreciation and dividend income benefits.
However, it's important to note that stock prices are influenced not only by commodity prices but also by various factors, including company management quality, industry competition dynamics, and the macroeconomic environment.
- Commodity Fund Investing
Commodity fund investing mainly falls into two categories: actively managed funds and passive index funds.
Passive index funds focus on replicating the performance of commodity indices and are characterized by low transaction costs and high transparency.
In contrast, actively managed funds involve fund managers who actively select investment targets and timing based on market dynamics and personal judgment.
If a fund manager possesses exceptional investment skills, they can achieve better returns through prudent asset allocation across various market environments.
It’s worth noting that fund investments come with management fees.
Actively managed funds typically have management fees ranging from 1% to 2%, which can partially erode investment returns.
The performance of these funds is heavily dependent on the investment acumen of the fund manager and market conditions; if a fund manager misjudges the market or if actual trends deviate from expectations, fund performance may suffer.
(Source: Freepik)
How Does Incorporating Commodities Affect Portfolio Risk?
After incorporating commodities into an investment portfolio, the changes in risk can be reflected in two main aspects:
On the one hand, commodities can reduce the correlation risk of the investment portfolio.
The price volatility logic of commodities is entirely different from that of other traditional assets (such as stocks and bonds).
Stocks and bonds are typically influenced by macroeconomic factors, corporate earnings, and interest rate policies.
In contrast, commodities are driven more by their unique factors; for example, agricultural prices may depend on weather conditions and planting acreage, while energy prices could be swayed by geopolitical events and global energy dynamics.
On the other hand, including commodities helps to lower the overall risk of an investment portfolio through diversification.
As the saying goes: Don’t put all your eggs in one basket.
The lower the correlation between assets, the lower the risk of the constructed investment portfolio.
When you add commodities to your investment mix, even if stocks or bonds underperform, commodities may exhibit completely different price movements—thereby cushioning overall losses.
