global commodities are enticing to investors with stunning performance at times, and exchange-traded funds (ETFs) have made it easier than ever to invest in them. Despite these periods when the asset class outperforms many investors, even many professional traders in the short term are leaving the business.
Commodities are harder to understand
Most investors are familiar with how the stock market works, but investing in commodities is much more complex. Commodities are primarily traded using derivatives known as “futures contracts,” where the seller agrees to deliver a commodity to the buyer at a specified time and price in the future for a fee. Therefore, the current price of the commodity has little to do with what investors will earn from the commodity contract in the future.
You do not receive interest or dividends
Many stocks pay dividends, and most bonds pay interest, but commodities do not naturally generate any interest or dividends. The value of commodities depends exclusively on global production, commercial demand, and speculation, while stocks represent ownership in a business that typically grows in value over time. For example, in the ten years leading up to December 2020, gold prices had an inflation-adjusted annual return of only 1.6%. This is low compared to 9.6% for the S&P 500 index.
You have to pay additional fees
Commodities are physical items that must be transported, stored, managed, and insured against loss. For example, raw gold must be stored in a safe and insured against theft, and crops must be insured against losses due to bad weather or fires. These expenses are collectively known as “carrying cost” or “storage fees,” which put negative pressure on an investor’s overall returns in the long run.
Commodities are not a good hedge over time
Many investors use commodities as a hedge to reduce portfolio risk, as they have a low correlation with other asset classes. The problem is that many commodity indices heavily focus on a few commodities, such as crude oil. Many crises that tend to outperform on a speculative basis are short-lived. Recently, there has also been a positive correlation between stocks and crude oil and a negative correlation between bond prices and gold.
You might not be able to sell at a good price
Many commodities lack liquidity, especially when traded in futures. Futures exchanges address these issues by marking the value of contracts at market close, leading to significant fluctuations in portfolio valuations associated with the market.
Some commodity markets are manipulated
Most investors are aware of the Organization of the Petroleum Exporting Countries (OPEC) and its impact on crude oil prices, but many lesser-known cartels dominate commodity markets like potash and diamonds. This means that these markets may not be solely influenced by supply and demand but rather by a small mood of traders or investors wishing to keep prices at a certain level.
When commodities are appropriate
Commodities may be a poor investment for most investors, but there are situations where they can be suitable. In particular, precious metals like gold can be useful short-term protection when an investor is concerned about a crisis. Gold prices tend to rise when stock prices fall significantly (15% or more), making it useful short-term protection against downturns.
In some cases, investors may also identify opportunities where commodity prices may move in predictable trends. A good example would be crude oil markets before an OPEC meeting where an increase or decrease in production is broadly anticipated. Although prices may have risen already in anticipation, these events usually lead to volatility that can be lucrative for short-term traders or speculative investors.
Finally,
Commodities can also be a useful hedge against other investments. A good example is a portfolio heavily focused on crude oil companies. If an investor wants to protect themselves from falling crude oil prices, they can use futures contracts to hedge the commodity risks while later benefiting from the company’s risks and rewards.
Source: https://www.thebalancemoney.com/why-you-should-rethink-investing-in-commodities-4153957
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