What is a commodity?
Briefly put, a commodity is stuff. More precisely, it is a contract for the future delivery of stuff. Rarely do investors take delivery of cattle or piles of wheat. Contract prices move up and down according to market conditions, and at some point before the delivery date an offsetting transaction should occur. If you had purchased something, you sell it; and if you had sold it, you would need to buy it. Regardless of the order in which you bought and sold, your profit would be the difference between selling and buying prices. Meanwhile no actual commodities change hands.
Commodities have a purpose beyond speculation or theoretical investment. Farmers can guarantee a certain level of income by agreeing to sell their product at an opportune time instead of depending on prices at harvest. Food manufacturers can lock in costs and supplies buying from these farmers ahead of time. Similar activities allow miners, oil drillers, and other extractors to secure income levels while simultaneously allowing utilities, manufacturers and processors to lock in costs and needed inputs.
For the rest of us, who neither produce nor use raw materials, commodities are just another way to make or lose money. Examples of what investors can bet on include precious metals such as gold, silver and platinum; industrial metals such as steel and copper; and agricultural products such as wheat, corn, cattle and the classic pork bellies.
Why you should avoid investing in commodities
No expectation of return
Commodities entail no earnings, no income, no operations – no innate reason for growth. Though it is logical to expect commodities to keep pace with inflation, the growing service orientation of our economy combined with productivity gains has frequently led to spells in which commodities drop in value despite price increases in other areas.
It is a gamble you will probably lose
Commodities represent a bet – pure speculation. Buying and selling in these markets, for a non-producer or user, is like playing blackjack or craps in Las Vegas. You might win. But you probably won’t.
Do you have a better read on weather and harvests than farmers and agricultural experts? Do you understand metals better than geologists and mining experts? Did you attend the most recent OPEC meeting? If you answer ‘no’ to all three questions, you are at a terrible disadvantage, playing with a stacked deck where the other players know the card order.
What you should do instead
If your interest in commodities stems from reduced confidence in the regular securities markets, you would be better served by adjusting your asset allocation to a more conservative stance. You might sell some stock holdings and keep a higher portion of your assets in cash or bonds for a spell. Market timing should be avoided, but if your tolerance for risk is seriously reduced, taking corrective action is not wrong.
If you fear inflation and think commodities might provide some protection, remember stocks have historically provided the best hedge against rising prices. Thanks to the hard work of employees, guidance of managers and ownership of real property, corporate stock values tend to appreciate at a higher rate than consumer prices. Instead of gambling with commodities, beat inflation with time-proven equities.
If you’re thinking of commodities as a way to make a lot of money by outguessing experts, be realistic. Only put to risk an amount that you would take, and fully expect to lose, on a trip to Las Vegas or Atlantic City. Better yet, don’t put anything at risk.
* Data sources:
Stock returns: S&P Dow Jones Indices LLC; Standard & Poor’s 500 Index.
Oil prices: BP Statistical Review of World Energy, Brent crude.
Gold prices: COMEX – Commodity Exchange Inc., New York Mercantile exchange since 1994.
Price index: U.S. Department of Labor, Bureau of Labor Statistics, Consumer Price Index