Investing for Beginners .EU, investing Economics is extremely useful as a form of employment for economists.
John Kenneth Galbraith

Stocks and Commodities


You may ask how stocks and commodities related are. And the answer is simple: everything is related and especially in financial markets. Normally, if some of the main asset class (as stocks) looses or gains a lot of value, sooner or later other asset classes are reacting accordingly. 


Commodities are often described as one of the best investments, and many investment managers includes them in the investment portfolios at least for the reason of diversification. Well, diversification is one of the most important things during whole investment management process. Good diversification does provide not only safety but also better investment results. 


But is it commodities really that good investments for diversification? The true is that over short period the prices of stocks and commodities may go in different directions, and that happens pretty often. But such reason is not enough to include commodities in the portfolio. The thing is that commodities are an asset class that pays no dividends and no interest for you. If bought directly (without futures or funds) it even requires some storage expenses. Commodities are not worth to keep them in a portfolio for a long period. In other hand, commodities are too risky to be included in a portfolio for a short period. The volatility of commodities is one of the highest among the main asset classes.


However, if you believe very deeply that some particular commodity will rise in price very strongly, you should buy the stocks of the company that produces mentioned commodity. Of course it creates some additional risks, but also opens new possibilities over long run. Let’s just say that you are wrong and commodity will not rise neither will fall. It will stay the same level for several years. And you will earn nothing if you will hold that commodity at your portfolio. But if you will hold the stocks of the company that produces the commodity (if the price of commodity will stay the same company should keep its profitability), you should earn dividends from it. Even if the company does not pay any dividends, you should earn more not less. The financial mechanics of it is more difficult and I will not explain it in here. 


However, you may hear other investment professionals saying that pure commodities are better than stocks of companies (the producers of commodities). They say that commodities sill provide gold-worth diversification and is better that these kind of stocks. I would say such attitude is neither bearish neither bullish, at the best it is foolish. The correlation over long run will disappear, and as for short run, commodities are too volatile to be included in the investment portfolio at all (as well as stocks).


Such financial instruments as options or futures that are related to the prices of commodities should be interesting only for companies or purely for fundamental hedging reasons.


(Read another article about commodities)

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