A core principle of successful investing is diversification – not putting all your eggs in one basket. This means spreading your investments across different asset classes, such as stocks, bonds, and property.
The recent surge in inflation has many investors rethinking their asset allocation strategies. But what about venturing beyond the traditional options? Including commodities in your portfolio can be a powerful way to further diversify and potentially improve your risk-adjusted returns.
The Importance of Diversifying Your Portfolio
A single stock market crash could shatter your financial dreams without a diversified investment portfolio in place. Diversification helps mitigate this risk. By spreading your investments across asset classes with low correlations (meaning their prices don’t move in tandem), you minimise the overall portfolio’s volatility.
When stocks plummet, for instance, commodities might rise, offering a potential buffer. In select geopolitical and economic scenarios, different commodities fluctuate in value and commodity trading could provide you with risk-adjusted returns and less volatility.
Types of Commodities
Precious Metals
Gold, the quintessential safe-haven asset, has historically held its value during economic turmoil. This can be purchased in bars, coins or jewellery, and it can act as a hedge against inflation and deflation. The price of gold has reached a record high of £1,664 an ounce as economic tensions push investors into safe-haven assets.
Silver also offers diversification benefits and has industrial applications, potentially boosting its price during economic growth. It is always in demand as an industrial metal and in the renewable energy market.
Oil
While concerns about renewable energy sources are valid, oil is expected to remain a significant player for years to come. The International Energy Agency predicts oil demand to rise in 2024 due to post-pandemic economic recovery and demand from developing nations such as China and India.
Oil futures remain a favourite of traders since it remains a cornerstone of our modern world. You are unlikely to be handling actual oil barrels but you can invest in small producers, oil giants such as BP and Shell, or oil services firms.
Agriculture
Thanks to the ever-growing population, agricultural commodities such as corn, soybeans, cocoa, and wheat are critical for global food security and offer long-term demand. Prices can fluctuate due to factors like climate change, weather events and geopolitical tensions.
Why Commodities are a Good Way to Diversify
Commodities offer several advantages for portfolio diversification:
- Low Correlation: Commodity prices often have a low correlation with traditional stocks and bonds, meaning they move in different directions. This can help to offset losses in other parts of your portfolio.
- Hedge Against Inflation: Inflation erodes your purchasing power. Historically, commodity prices tend to rise with inflation, offering a potential hedge against its negative effects.
- Tangible Assets: Unlike stocks and bonds that represent ownership in companies or debt, commodities are physical assets. This can provide a sense of security in a volatile market.