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Why Invest in Commodities?

Aug 17, 2007
Most of us are quite comfortable with investing in cash deposits, government bonds, and stocks for conservative risk-averse investors. We hear these products discussed widely in the financial media. But rarely do we hear commodities discussed as an investment alternative. After all, what do commodities have to offer that stocks haven't already provided?
Here are reasons why commodities can be a good investment:

- By diversifying your portfolio, the risk can be reduced, especially during recessionary periods such as bear markets where stocks tend to decline and lose value. Commodities tend to rise and this would counter the loss of portfolio value.

- Commodities trend better than stocks, not only on individual or also stock sectors and stock indexes. As such they are a better long-term investment vehicle. Trends tend to last short term such as a few months to a few years. When the trend begins, it is very unlikely there will be sharp reversals or unpleasant surprise.

- Commodity markets have large liquidity. Not all stocks are liquid even if they look very attractive earnings-wise, but exiting can be a painful process. In commodities, all commodities traded are highly liquid.

- Commodities have been trading for more than a century. More than 90% of stocks come and go. None are changed any way so there is more reliability in back-testing (review your strategy on past historical data) than others instruments such as futures and stocks where premiums change from one expiring contract to a new one, or stock-splits.

- At tax time, profits from commodities pay lower taxes than profits from stocks. In addition, there is no need to itemize all the transactions line by line where all stock transactions must be itemized. Long term or short term capital gains do not apply in commodities.

- Due to leverage, the gains can be spectacular, possibly many multiples of the original equity. For a small sum in the account, it is possible to more than double the account equity in a very short period of time.

- If the financial objective of the person is aggressive where he has high tolerance for risk, then commodities may fit is personal tolerance for risk. With a small equity, he can use for high-growth part of the entire diversified portfolio.

Here are some reasons against the investing in commodities:

- Daily Price Limit can prevent the investor from exiting a position if prices have reaches the day's maximum price rise or decline allowed. This is especially difficult when his position is in a loss. Many times, margin calls will automatically exit the position. However, the account can be in the negative where the investor must fund additional money to the account to get back in black.

- There is lack of research materials covered in the media or in print compared to those covering stocks. The most popular financial books mainly use stocks as examples. Most brokerages and investment banks whose analysts cover industries and stocks. Investors like to see easily available and up-to-the-minute information which can be made available but not in a wide variety.

- The leverage is high, so small losses can make a big impact on the equity. This is a common scenario where the uninitiated and unprepared will see the account being wiped out.

- Future contracts constantly expire. If it's a long-term holding, contracts must be managed properly changing to forward contracts. This can be tricky because premiums change from one forward contract to the next. Acute attention must be given in doing so.
If the investor is risk-averse in which he is content with small return year to year, then commodities might not be the right investment.

This list should not be considered final for any person to decide if he or she should trade commodities. There are many other factors and priorities, such as financial situation, time and preparation of each person to commit before deciding. To effectively profit from any market, due diligence and preparedness is the method to obtain the desired objectives. Weigh each pro and con carefully and verify the arguments for oneself before committing hard-earned money to waste.
About the Author
Larry Swing
CEO & Head Swing Trader
swing trading with mrswing.com
theboss@mrswing.com
+1 (281) 968-2718
Yahoo & Skype ID: larry_swing
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