To most investors, investing in commodities seems hopelessly complicated and treacherous.
My first visit to the commodity trading pit of the Chicago Mercantile Exchange (CME) was memorable. The swirling, bright-colored jackets and the shouting, jostling, and rapid hand signals were captivating and reminded me of a wrestling ring rather than a business setting.
It was also the polar opposite of my later visit to the currency trading floor of JP Morgan at 23 Wall Street: row after row of white shirts hunched over flickering computer screens.
Commodities sure looked like more fun to me.
My image of investing in commodity markets hasn't changed all that much since. It's a volatile and wild ride, where even a tiny bit of new information affecting supply or demand can send prices spinning. Weather, transportation costs, economic forecasts, currency movements, and many other factors affect how prices change minute to minute.
I do approach commodities trading cautiously, since expert traders who focus all day long on a single commodity tend to get it wrong as often as they get it right. Still, I have to admit the idea of making or losing a pile of money in a very short time gets my blood pumping.
So how should you approach commodities, and what should you do right now?
The Game Has Changed
As recently as a decade ago, most investors didn't even think of investing in commodities except through companies like Alcoa (NYSE: AA) for aluminum, Freeport-McMoRan (NYSE: FCX) for copper, or Comstock Resources (NYSE: CRK) for natural gas.
This can work well. For example, Alcoa is up sharply over the last six months. But this strategy also brings into play significant company risk.
Fortunately, the game changed with the arrival of exchange-traded funds (ETFs). ETFs give average investors the chance to get into the game with a just a click of the mouse.
The choices are breathtaking:
- Coffee — iPath Coffee (NYSE: JO)
- Sugar — iPath Sugar ETN (NYSE: SGG)
- Lead — iPath Lead ETN (NYSE: LD)
- Nickel — iPath Nickel ETN (NYSE: JJN)
- Corn — Teucrium Corn Fund (NYSE: CORN)
- Grains — iPath Grains ETN (NYSE: JJG)
- Cotton — iPath Cotton ETN (NYSE: BAL)
- Tin — iPath Tin ETN (NYSE: JJT)
- Aluminum — iPath Aluminum ETN (NYSE: JJU)
- Silver — iShares Silver Trust (NYSE: SLV)
- Oil — iPath S&P GSCI Crude Oil Index (NYSE: OIL)
- Palladium — ETFS Physical Palladium Shares (NYSE: PALL)
- Natural gas — iPath Natural Gas ETN (NYSE: GAZ)
- Timber — Claymore Beacon Global Timber Index (NYSE: CUT)
- Livestock — iPath Livestock ETN (NYSE: COW)
A Common-Sense Commodity Strategy
Given the complexity and volatility involved in commodities, you must have a common-sense strategy if you plan on having any success. So here's an easy one: have a small allocation in a broad basket of commodities in your portfolio.
This should make your overall portfolio less volatile and help preserve capital since commodities don't usually move in lockstep with stocks. In addition, raw materials provide you with a natural inflation hedge.
A great conservative play right now would be the PowerShares DB Agricultural ETF (NYSE: DBA). DBA is up 10.2% so far in 2014, providing investors a nice uptrend.
Here are the commodity weightings in this basket:
- Sugar: 12.44%
- Coffee: 11.91%
- Cocoa: 11.21%
- Live cattle: 8.68%
- Corn future: 8.33%
- Soybean future: 8.14%
- Wheat future: 5.64%
- Corn future: 5.35%
- Lean hogs future: 5.19%
- Soybean future: 4.42%
This broad-based basket of agricultural commodities tends to be less volatile than precious or industrial metals.
In addition, the long-term bull story is very convincing. The world population growth rate of 200,000 a day combined with rising incomes is driving food prices ever higher.
To meet this growing demand, the World Bank estimates that farms worldwide will have to produce more food in the next 50 years than they did in the previous 10,000 years. That's nothing to shrug off.
So get out there and add some commodities to your global portfolio today.
Until next time,
Carl Delfeld for Wealth Daily