An asset class that has performed consistently in the past and has given extraordinary returns during periods of extreme and unexpected inflationary episodes and strong economic growth. Commodity Market has shown persistent development globally due to rising level of demand especially from the developing countries.
Having some exposure to commodities is an indication of a well-diversified and smart portfolio. Commodities offer diversification benefits because their return characteristics are different than those of stocks and bonds. It serves as an alternative investment outlet for investors. Investors in commodities do not need to physically carry and store commodities. The commodity market can serve as a medium for investors to hedge their exposure in equity and debt markets. This is because commodities, such as precious metals, real estate, etc move in opposite direction with the traditional investment markets over a long term. They are a good source of investment even during tough times.
Commodity market offers following benefits to an investor:-
Hedging: Commodity trading is a useful tool for producers where they can hedge their exposure in any physical commodity at the exchange platform.
Diversification: Adding commodities to a portfolio may enhance risk-adjusted returns as commodities generally have low or negative correlation with many asset classes. Other factors constant, well diversified portfolios with low correlated assets tend to have lower volatility of returns.
Hedge against Inflation: Inflation affects investors as it erodes the value of the money held by them. However, it tends to affect commodities contrarily from other financial products. Investment in commodities generally benefit from an inflationary environment.
Hedge against Event risks: Geo-political events like wars and supply glitches due to natural calamities like droughts and floods generally hamper profitability of companies but may impact the supply of, and increase the demand for, certain commodities. Containing commodities in a portfolio may offer a potential hedge against many event risks.
Price Discovery: Commodities are traded on exchanges which execute a transparent process of trading between various participants. Fair price discovery is ensured through large-scale participation of different kinds of participants like hedgers, arbitrageurs and speculators. The large participation warrants views and expectations of a wide section of people concerned with that commodity.
Transparency: There are no company specific news attached with the commodity market. Dealing in commodities is free from insider trading and hence a fair trading is ensured.
Low Margins: Trading in commodity market demands low margin amount, roughly 5 to 10% of the total value of the contract. This is much lower compared to other asset classes. The low margin facilitates initiating large positions at lower capital. This provides an investor more leverage and thus the ability to generate higher returns.
Simple Economics: Knowledge of simple economics of demand and supply is what is required to trade in it. More the demand for a commodity higher is its price and vice versa.
Commodities have an intrinsic value, purely based on demand and supply in the economy. The prices of most agricultural commodities offer good potential for upside as the land availability dwindles and consuming population increases.
Commodities such as crude oil and natural gas also have an upbeat future as the demand for energy is expanding globally. Not to forget, metals such as gold and silver have always been the favorite of investor fraternity since centuries. It makes sense to allocate a part of your investment in commodities for diversification as well as to add more flavour to your portfolio.