In times of great market turmoil, many smart investors turn to commodities as a means of navigating through this tumultuous time. This may seem strange to some due to the inherent risk that is involved with commodity investment, but there are many good reasons for this. Commodities which include products such as oil, gold, and agricultural products provide advantages during a crisis that you simply cannot get from other asset classes.
Here are 5 reasons why commodities do well during periods of market turmoil:
1. Commodities Act as a Hedge Against Inflation
Perhaps the most important reason for investing in commodities is that during times of market turmoil, they act as a protection against inflation. During crises there tends to occur shortages of important goods. This scarcity often leads to rising prices and inflation. When inflation occurs, the prices of commodities usually rise with them making for an attractive investment.
Crises can also lead to monetary inflation. As opposed to price inflation, monetary inflation happens when central banks increase the money supply to support the economy in some way. This type of inflation can cause the price of commodities to rise as well.
2. Commodities Tend to Not Correlate with the Stock Market
Another reason why commodities often do well during times of stock market turmoil is that their prices are generally uncorrelated with the prices of stocks and other asset classes. This can be interpreted that because commodities are a fundamentally different type of asset than stocks, their prices do not necessarily fall when the prices of stocks fall. Additionally, commodities can generate positive returns when stocks take a hit.
It is important to understand that commodities are not always entirely uncorrelated with the stock market. A crisis that lowers the demand for goods can adversely affect both the stock market and many commodity markets as well.
3. Commodities Provide Portfolio Diversification
One of the most important factors that contributes to successful investing is portfolio diversification. This means allocating your investments across different asset classes. If one type of assets falls, there’s less of a chance that the entirety of one’s investment portfolio will suffer. During times of market turmoil, many investors see the value in this strategy and employ it by investing in commodities. This rush can contribute to rising prices which is why a smart investor should always employ this strategy.
It is necessary to note that investors should diversify their investment portfolios with a wide range of assets. This includes not only commodities but also fixed-income securities, such as bonds, and real estate.
4. Commodities Can Provide High Returns
Commodities can be considered a high-risk high-return investment. During the periods of high inflation that often accompany turmoil they have historically netted ROI’s. Over the last 50 years, whenever inflation for a given year has exceeded the median level of inflation, the average annual rate of return for commodities has been close to 22%. This can buffer the losses from stocks, and it explains why many investors flock to commodities during times of turmoil.
5. Commodities Can Provide a Safe Haven
Many investments in precious metals can provide a haven during troubling periods of economic downturn because they have held their value and usefulness throughout time. This holds especially true for gold and other precious metals used in everyday necessities like microchips, batteries, and even medicine.
However, it must be said that not all commodities act as a haven during turmoil. This is especially true of soft commodities such as agricultural products which have a short shelf life. Even some hard commodities such as oil do not act as such as seen recently with travelling crawling to a minimum.
While commodity investing has its risks and may not be right for every type of investor, it has many characteristics that make it an important component of a well-balanced investment portfolio. As such, smart investors should strongly consider this type of diversification as a component of their strategy.