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Commodities, Volatility and Your Portfolio

Chances are you know someone who is a strong advocate for owing commodities in the investment portfolio. Whether the choice is precious metal such as gold or silver, industrial commodities like copper or diamonds, or perhaps agricultural products like soybeans or coffee, there are some who believe that it is not only useful for diversification but actually necessary for an investment portfolio.
What would be helpful to those of us listening to this advocate on his or her commodity(ies) of choice would be to know just how much they have invested over time and just what the returns on that investment may have been. How else might we know if a particular commodity might be a good choice? Of course, if we take a step back and consider this as we would other investments, we might have a better grasp of what the upside and downside may be. First, think about volatility and what we see in the news with respect not just to stocks but to commodities. Just this year, copper has soared and then plummeted while gold and silver have experienced a substantial drop in recent weeks. Like individual stocks, then, timing is everything if you are dabbling in a commodity investment. Buy at the wrong time and you lose your shirt when the price tumbles. Buy and hold and your gains over time may be minimal and will be affected by when you finally sell – and you cannot always choose when that will be.
Another factor is liquidity of the investment. Owning the actual commodity as opposed to, say, an ETF that owns companies that own the commodity, presents a different set of concerns. Thus you will see folks owning physical gold while others own shares in companies that mine or refine gold. Those investments pose different issues with regard to ownership and, not surprisingly, different results with respect to performance. In different situations, it will be easier to liquidate a portion of an investment represented by stock, fund or an ETF than it will be with regard to physical metal (or whatever commodity we are addressing). Or vice versa.
If your overall goal is to get the best performance possible, then the risk and volatility associated with a specific commodity may be the way to go. After all, that is where the greatest potential for growth (or loss) is present. If instead you are looking primarily for protection for your principal and to avoid any unnecessary risk, then a more diversified and broader investment – say in a mutual fund or ETF representing a particular commodities sector – will likely serve you better.

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