The Learning-to-Invest.net Basic Investment Guide by Paul Jorgensen - HTML preview

Section 8 :
Commodities: owning things we really need

With all the current volatility in the world`s stock markets, a lot of people are wondering whether it makes sense to invest in anything at all at the moment. Well, I personally see drastic stock market drops as a chance to buy stocks on sale before the price eventually goes back up. But beyond that, there are alternatives to stocks for those who can`t stomach the current state of affairs.

An alternative to stocks is investing in commodities. What are commodities? They are raw materials used to create products that people really need. Things like food, agricultural products like wheat and cattle, oil and gas, and metals like gold, silver, and aluminum.

Most commodities used to be just sold at the local market. Obviously that would present some trouble for the individual investor who can’t store cattle or wheat at home. But in the 1800s, commodity future exchanges were set up. Future and option contracts on commodities can be traded on exchanges around the world. So you no longer have to possess the actual barrel of oil itself, you can possess a contract to own it in the future, and these contracts can be sold. Futures and options are advanced trading avenues and in my opinion are best avoided for the novice investor. But these days there are other ways to invest in commodities, like buying units in a mutual fund that buys commodity futures.

In recent years commodities prices have outperformed stocks and bonds. One reason is that demand for commodities from developing countries is increasing. As massive developing countries like China and India build infrastructure and increase manufacturing, steel, oil, and other commodities will be needed in huge quantities. Increased demand, coupled with decreased supply for some commodities such as oil, will continue to send prices higher. With Asia’s rapid development this will likely continue.

Commodities also move up when stocks go down. Commodities are real assets, unlike stocks and bonds, and they react differently to changing economic conditions. Commodities prices tend to increase with inflation. Stocks and bonds on the other hand, tend to perform better when the rate of inflation is stable or slowing. Since 1990, commodity prices have been negatively correlated with the S&P 500. Since commodities are not positively correlated with stocks and bonds, they diversify your portfolio and help reduce risk and increase returns over time.

Commodities are not only a hedge against inflation, but also a hedge against destabilizing events or catastrophes. Commodity prices rise during times of crisis such as wars and stock market crashes. After the Iraqi invasion of Kuwait, stocks dropped while commodities performed well. And during the stock market crash of 1987, stocks dropped by 30% while commodities held steady. There are people out there who horde gold as a way to preserve wealth in some coming cataclysmic event. I would never want to invest in only gold, but these people are right that in the event of catastrophe commodities like gold will be far more useful than stocks or cash (which will likely become unbelievably devalued if there’s a catastrophe of huge proportions).

That’s not to say that commodities are free of volatility. They are equally or slightly more volatile than the stock market, but they rarely drop at the same time as the stock market. In these volatile times with stocks continuing to drop or stagnate, commodities are an essential part of any diversified portfolio.
Thank you for reading the Learning-to-Invest.net Basic Investment.Guide. I hope that you learned something from it. More than that, I hope that reading it has aroused questions in your mind, questions that you will seek the answers to and deepen your knowledge of investment.

There are countless resources out there that are much more in-depth than this mini-ebook. Websites abound, and are no more than a Google search away. I will also be reviewing investment books on http://www.learning-to-invest.net in the near future and hope you will have a look.