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Do Commodities Belong in Your Portfolio?

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You'll never see a Project Runway-like show featuring financial products. But while new fads in investments constantly rotate in and out of fashion, some new ideas actually stick around and become classics.

One of the latest investment strategies to gain the attention of mainstream adventurers is commodity investing. Commodities have gone through both a boom and a bust, and now's a great time to ask the $64,000 question: Are commodities here to stay?

The ups and the downs
In early 2008, everything looked great for commodities. As stocks started to fall from their 2007 highs amid the Bear Stearns debacle, oil was hitting triple digits. Gold reached the $1,000-per-ounce mark for the first time. And with concerns about the financial system pushing the U.S. dollar down, many investors started looking to commodities as a way of protecting their wealth. New exchange-traded funds began to emerge that gave investors easy ways to invest in commodities.

Then the bottom fell out of the commodities market. By the end of 2008, the vast majority of commodities had fallen substantially, and gasoline topped the list with a 59% drop. Overall, the CRB index, which is a broad measure of commodities prices, lost 36% of its value in 2008.

After the 2008 bust, prices of many commodities rebounded. Just last week, gold prices pushed to new record highs. Yet recently, most other commodities have started to give back some of their gains. That makes now a reasonable time to consider whether adding commodities to your portfolio will help your overall results.

Commodities for diversification
One benefit of owning commodities is that their returns aren't strongly correlated with returns from the stock market. That's a positive for investors following an asset-allocation strategy, as it means that when stocks, bonds, or other components of your portfolio lose value, it doesn't necessarily mean commodities will follow suit.

In a recent interview with the Fool's Rule Your Retirement newsletter service, asset manager and author Robert Gibson gave his case for making commodities one of the core components of your retirement portfolio. He pointed to analysis showing that although commodities earned the worst returns of four types of assets from 1972 to 2009, including commodities among a four-asset portfolio produced returns nearly as good as the best asset class alone, with far less volatility along the way.

How to get commodities exposure
If you want to add commodities to your portfolio, you have a number of ways to get exposure. Here are a few, along with some good examples:

  • Commodity stocks. Companies that produce commodities typically earn higher profits when prices rise. Copper prices are seen as a predictor of economic activity, for example, so if you think the economy will continue to strengthen, then buying shares of Freeport-McMoRan Copper & Gold (NYSE: FCX  ) or Southern Copper (NYSE: SCCO  ) is a way to profit if your belief is correct. Similarly, Chesapeake Energy (NYSE: CHK  ) shares have risen and fallen with the fortunes of the natural gas market, which now seems poised to rebound.
  • Broad commodity ETFs. Because commodity stocks are prone to company-specific risks such as corporate mismanagement, some prefer to take direct positions in commodities. Rather than going to the futures market, though, the broad commodity ETFs iShares GSCI Commodity Indexed Trust (NYSE: GSG  ) and PowerShares DB Commodity Index Tracking Fund (NYSE: DBC  ) track major commodity indexes that include everything from aluminum to zinc.
  • Single-commodity ETFs. Instead of making a broad bet on the entire commodities market, you may prefer to pick and choose individual commodities. You can't find a specific ETF for every commodity, but with the major ones, you have good choices. For instance, SPDR Gold Trust (NYSE: GLD  ) owns nearly 42 million ounces of gold, with each share representing roughly 1/10 of an ounce. U.S. Oil Fund (NYSE: USO  ) tracks the movements of crude oil futures, although over the long term, it has suffered from pricing disparities between futures prices and the spot market.
  • Physical commodities. In some cases, especially precious metals, buying the actual commodity is feasible. We don't recommend it for agricultural commodities, though, unless you have a big freezer: live-hogs contracts, for instance, involve delivering 40,000 pounds of meat. That's a lot of bacon.

Trading commodities can certainly get complicated. But by incorporating simple strategies into your overall portfolio, adding commodities can help you improve your investing results and smooth out your portfolio's performance over time. That makes commodities worth a second look even if they go out of fashion.

Commodities by themselves won't rescue you from financial Armageddon. But Fool contributor Morgan Housel has the answer. Read his six ways to save the world.

Fool contributor Dan Caplinger needs to find a way to invest in macaroni and cheese futures, in order to hedge his daughter's future consumption. He owns shares of Freeport-McMoRan and Chesapeake Energy. The Fool also owns shares of Chesapeake Energy, which is a Motley Fool Inside Value pick. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy lifts you up where you belong.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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