×

Now is the time to add commodities to your portfolio

With commodities currently sitting at or near multiyear lows, now may be a good time for investors to take advantage of lower prices and gain exposure.

Commodities — such as precious metals, including gold and silver; industrial materials, such as iron ore and copper; and agricultural products, such as wheat and pork bellies — can offer strong diversification benefits to an investment portfolio.

It's essential that investors look at the overall market factors that could make now a good time to add commodities to their portfolio.

Pedestrians walk past clocks in the Canary Wharf financial, shopping and business district in London, U.K., on Tuesday, June 21, 2016.
Simon Dawson | Bloomberg | Getty Images

One of the top reasons to look at commodities is the diversification benefit they offer. The addition of commodities to an equity-only portfolio can lower the overall volatility, as commodities are "non-correlated" to equities and fixed income, the most popular investment classes.

Second, commodities can be a safe haven during tough markets. Many investors have turned toward commodities during times of global economic uncertainty. For example, gold was one of the original stores of wealth, and individuals still turn to it during times of crisis.

Commodities can also offer an inflation hedge. Despite central banks' efforts to create inflation by running currency printing presses overtime, this money is ultimately only worth the paper it is printed on. On the contrary, commodities — such as gold — maintain intrinsic value, making them a good hedge against the deteriorating value of currencies.

More from Portfolio Perspective:
Investors flock to tax-efficient ETFs
Hidden fees eat away at investments
Survey global outlook to exploit investment trends

As measured by the popular CRB Commodity Index, prices of the major commodities peaked in 2011 and trended dramatically downward through the end of 2015, when they reversed their course, with precious metals outpacing all other asset classes over the first half of 2016.

Commodities have been trading in a fairly tight range for the past couple of months, but global demand is beginning to increase, especially in the relatively fast-growing markets of Asia. At the same time, the lower prices of the past several years have led to production cuts of many of the major commodities — a combination that could lead to a supply squeeze in the coming years.

These factors could help commodities break out of the tight range they've recently been trading in and potentially reestablish the rally we saw during the first half of the year.

There has been bit of a pause in the commodity rebound due to investors' increased expectations of an interest-rate increase in the United States this summer.

However, those expectations have been tempered. Signs are pointing to rates remaining lower for longer, not only here in the United States but also on a global level — positive news for commodities, and savvy investors.

Slower global growth has further kept a lid on commodity prices, but with several countries planning massive infrastructure projects to stimulate their economies, greater demand for industrial metals, like copper and iron, should be on the horizon.

On the agricultural front, prices could also be poised to increase as expanding middle classes in emerging markets such as India and China shift their diets and start consuming more proteins and sweets.

Your Wealth: Weekly advice on managing your money

Sign up to get Your Wealth

Please enter a valid email address
Get this delivered to your inbox, and more info about about our products and service. Privacy Policy.

There are a few different options for retail investors when it comes to gaining exposure to commodities. One of the riskier, though more direct, approaches is to purchase futures contracts. Given the risk and volatility of these types of securities, average investors are likely to do better with a different approach, such as investing in the stock of companies involved in the commodity markets.

This could include buying stock in mining companies, energy companies or agricultural companies.

The downside to this approach is that an investor loses some of the diversification advantages, since the company's stock price is subject to other macro-economic factors. Most retail investors would do better by looking at diversified commodity exchange-traded funds, which track one of the broad-based commodity indexes.

There are many reasons to consider adding commodities to a portfolio. Taking the time to explore your options now can mean added diversification, lower risk and solid growth opportunities for your portfolio later.

— By Chris Gaffney, president of the World Markets division of EverBank