How To Invest In Commodities and Why?

Summary

This script explores the reasons for including commodities in a portfolio, such as diversification, inflation protection, and speculation. It categorizes commodities into energy, precious metals, agricultural, and industrial metals, highlighting their volatility and correlation. The video explains market drivers, including interest rates for gold and economic activity for energy and industrial metals. It discusses the unpredictability of agricultural commodities and the importance of understanding commodity indices and exposure methods, such as futures or physical storage, with strategies to minimize roll costs. The script also guides viewers on selecting UK and US commodity funds based on expense ratios and provides insights into fund flows and performance.

Takeaways

• 📈 Diversification: Commodities can provide diversification in a portfolio, reducing reliance on equities and bonds.
• 🛡 Inflation Protection: Commodities, particularly precious metals, can act as a hedge against inflationary spikes.
• 💰 Speculation: Some investors are interested in commodities to speculate on prices, such as the price of oil.
• 🏗️ Commodity Categories: The script categorizes commodities into energy, precious metals, agricultural, livestock, and industrial metals.
• 📊 Volatility: Commodities are characterized by high volatility, with single commodity funds being the most volatile.
• 🔗 Correlation: Understanding the correlation between different commodity funds is crucial for effective diversification.
• 💼 Risk and Reward: Commodities can introduce both risk and potential for high returns to a portfolio.
• 🌐 Market Drivers: The script discusses various drivers behind commodity prices, including interest rates, currency strength, and geopolitical events.
• 📊 Commodity Indices: There are several commodity indices that funds track, each with different weightings and exposures.
• 📅 Futures Market: Many commodity funds get exposure through the futures market, which involves roll costs and contango or backwardation.
• 🏆 Minimizing Costs: Strategies like roll optimization can minimize costs in commodity funds, impacting long-term returns.

Q & A

Why might someone want to include commodities in their investment portfolio?

Commodities can be included in a portfolio for diversification away from equities and bonds, protection against inflationary spikes driven by commodities, or for speculation on the price of commodities like oil.

What are the four broad categories of commodities mentioned in the script?

The four broad categories are energy commodities, precious metals, agricultural commodities, and industrial metals.

How does the volatility of commodity funds compare to global equity funds or the S&P 500?

Commodity funds tend to have higher volatility, with single commodity funds being the most volatile, compared to global equity funds or the S&P 500.

What is the significance of the correlation between different commodity funds when considering diversification?

The correlation between funds is important for diversification because funds that are highly correlated move together, providing less diversification benefit than those that are less correlated.

Why are some commodity funds considered 'risky' and others 'safe haven' commodities?

Risky commodities include energy commodities and industrial metals, which tend to sell off during equity sell-offs. Safe haven commodities, like gold, are seen as a hedge against equity and provide protection during market downturns.

What factors influence the price of gold?

The price of gold is influenced by factors such as low interest rates, a weak dollar, and equity market fear, which can drive investors towards gold as a safe haven.

How do supply shocks typically affect energy commodities like oil?

Supply shocks, often resulting from political instability or conflicts in major energy-producing regions, can significantly drive up the price of energy commodities like oil.

What is the difference between exposure to commodities via the futures market and direct physical exposure?

Futures market exposure involves buying contracts for commodities that will be delivered at a future date, while direct physical exposure involves actually storing the commodity, like gold in a vault.

What is 'roll cost' in the context of commodity futures, and how can it be minimized?

Roll cost refers to the cost of moving exposure from one futures contract to another as the contract nears its delivery date. It can be minimized by moving further out on the futures curve or using dynamic strategies to take advantage of changes in futures prices.

How do commodity indices differ in their weighting and composition?

Commodity indices differ in their exposure to broad categories of commodities, the number of commodities they include, their selection criteria, and how often they are reviewed.

What are some factors to consider when choosing a commodity fund for investment?

Factors to consider include the fund's expense ratio, size, whether it is priced in the investor's local currency or U.S. dollars, and whether it is optimized to minimize roll costs if it gets exposure via futures.