Allocate commodities in your portfolio

on Nov 1, 2012 in Commodity, Home | 1,896 comments

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The traditional mainstays of any portfolio are equity and fixed income investments. While finding the appropriate balance between the two can have a paramount impact on your portfolio, there is one asset class that investors overlook: commodities.

Now, with the rapidly expanding ETF industry, investors can establish a long term exposure to commodities without having to participate in futures markets by trading on margin and the roll process which takes place on a regular basis to maintain constant futures exposure.

While commodities are a cornerstone of investment portfolios, they do not deserve a major allocation. Even though commodities provide inflation hedge, they are subject to high volatility and price correction. Instead, they should be used as satellite investment and account of no more than 5% of your portfolio depending on your investment strategy.

When you pick asset classes, you intend to bring the correlation down. Generally speaking, bonds are only minimally correlated with equities which are one of the reasons investors like holding them in their portfolio. But commodities have actually been negatively correlated to both equities and bonds historically. Commodities are the only asset class negatively correlated to bonds, making them a powerful diversification tool.

The returns should do well over a holding period of a couple decades if you buy a broad index of commodities. Investing in a commodity ETF is one of the easiest ways to participate in the commodity markets and also diversify your investment portfolio.

For decades, commodities remained for good reason the exclusive domain of professional traders, financial institutions and hedge funds. Futures trading require an in-depth understanding of economic trends and the ability to anticipate the impact those trends will have on the cost of goods, as well as the willingness to monitor trading activity on a daily basis.