Friday, February 12, 2010

Invest In Commodities And Diversify Your Portfolio

Why You Should Diversify?

Any smart investor will tell you that it is important to diversify your investment portfolio. Diversification doesn’t just mean investing in different investment products but it also means investing in products that have low or no correlation to each other. Such investments are also called Alternative Investments.

Alternative Investment Options

There are many different options when it comes to alternative investments, such as Hedge Funds, Private Equity, Real Estate and Commodities. All these investments have a low correlation to traditional investments such as equities, bonds and money market funds.

Where Can You Invest?

As a general investor, you probably will not have access to hedge funds and private equity. The options for you then are investing in real estate and commodities in order to diversify your portfolio. In this article, we are going to discuss about investing in the commodities market.

Commodities markets have garnered a great deal of interest in the recent past as prices of commodities went up. ‘Commodities’ has developed into a separate asset class for people looking to diversify from traditional asset classes such as equities and bonds. So how do you gain exposure to this asset class?

Alternatives In Gaining Exposure To Commodities

You can gain exposure to commodities through different alternatives such as Direct Investments, Commodities Derivatives, Commodity Funds, Equities related to Commodities and Exchange Traded Funds. As a general investor, it is not practical for you to invest directly in physical commodities. Commodities, Derivatives and Funds are options for the more sophisticated class of investors that can actively manage their portfolio. Therefore, the options available to you are investing in Equities related to commodities and Exchange Traded Funds that track commodities indices.

Equities Related To Commodities

One of the ways for you to gain exposure to commodities is through investing in equities of listed companies that derive majority of their revenues from buying and selling physical commodities. The profits of such firms depend on the prices of commodities. However, this would require some active management from you.

Exchange Traded Funds

Investing in Exchange Traded Funds that track commodities indices is one of the easiest ways for you to gain exposure to commodities. By investing in Exchange Traded Funds, you can gain exposure to a number of commodities as an investor and do not have to actively manage your portfolio. Exchange Traded Funds can give exposure to the entire asset class. Exchange Traded Funds are traded on stock exchanges and are open ended securities which mean that you can exit from your investment easily. Exchange Traded Funds are highly liquid and are traded on regulated exchanges.

Our Recommendation

Currently, investing in funds that track gold is a good option for you as gold prices have seen a surge in prices. There are many Exchange Traded Funds that track gold, such as the Market Vectors Gold Miners ETF traded on the New York Stock Exchange. The fund gives you exposure to gold by replicating the NYSE Arca Gold Miners Index as closely as possible. Market Vectors Gold Miners currently trades at $42.77. The SPDR Gold Trust ETF also gives you exposure to gold. The fund currently trades at $106.53 on the New York Stock Exchange.

How Much Should You Invest In Commodities?

In this article, we have discussed the ways you can diversify your investment portfolio by investing in commodities. So how much of your portfolio should have exposure to commodities? The answer depends on your risk appetite. Commodity investment has its fair share of advantages. It provides a natural hedge against inflation. It has a low correlation to equities and bonds. However, commodity prices can be very volatile. We only have to look at price of oil in the last year and a half to gauge how volatile commodity prices can be. Therefore, if you are a risk averse investor, we recommend that you only dedicate a small portion of your portfolio to commodities.

Long Term Outlook For Commodities

As we have seen so far, investing in commodities can help you to diversify your portfolio and provide you with protection from inflation. The long-term outlook for commodities depends a lot on demand from emerging economies like China. Commodity prices have been lower in the recent past as demand has lowered due to a downturn in the global economy. However, with a recovery in global economy, we can expect that the demand for commodities, especially from emerging economies will be solid. Our long-term outlook for commodities is therefore bullish.

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