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Should I invest in commodities?

Category: Financial Planning&Investment

Our colleagues at Timeline, who manage the portfolios we recommend to our clients, have put together a paper on the investment case for commodities.

We class commodities as ‘alternative’ investments. Unlike ‘traditional’ assets such as bonds and equities, commodities are physical assets that produce no income and may incur storage and transportation costs. This makes working out a fair value for them difficult as this usually involves forecasting future cashflows.

How would I invest in commodities?

The simplest way investors can gain exposure to commodities is to buy and store them themselves. The practicalities, and security issues, involved with this make holding a diversified portfolio of commodities in this manner difficult. Because of this, one of the primary ways investors gain diversified exposure to commodities is via commodity funds.

These funds usually speculate on the future price, and their long-term results depend on the consistency and accuracy of the fund managers’ predictions.

Is investing in commodities a better idea when inflation is rising than investing in equities?

It’s important to understand that ‘commodities’ includes a wide range of sectors. Although they may have performed well in comparison to bonds and equity in recent times, individual commodity sectors have not performed consistently over time. This is because the factors that influence supply and demand and the nature of production differ for each.

The law of supply and demand essentially drives commodity prices. For example, if supply drops due to sanctions on Russian oil, but demand remains constant or increases, it will result in price increases. This is because commodity prices tend to rise during periods of inflation, and investors have traditionally seen commodities as protection, or a ‘hedge’, against inflation.

The paper notes that equities have historically not been a good inflation hedge over short-term horizons. However, equities come into their own, as is so often the case, over the long term. The paper notes that over 5, 10, and 20-year periods, the chance of achieving a positive real return is far higher by investing in equities rather than commodities. One factor in this is the spread of returns, making the returns of commodities highly uncertain over more extended periods.

Do the portfolios you recommend to clients hold commodities?

Considering the above, we agree with Timeline’s decision not to include commodity funds in their portfolios. However, our clients still have indirect exposure to commodities because the funds they invest in hold mining and commodity-producing companies. Therefore, our clients are well-placed to benefit from commodity returns over the long term. Maintaining a global approach to investing also provides our clients with the best long-term hedge against inflation.

If you need help putting together a robust investment plan, feel free to book a free no-obligation chat here.

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