|by John Jagerson, Analyst at
Commodities can have great trends and represent a
diversification alternative for longer term profit
opportunities. However, very few individual investors are
willing to trade futures, which is traditionally how
traders get access to that market. There are some excellent
low cost alternatives to futures but which method is best
really depends on what your investing objectives are.
To see the video that accompanies this article,
The two most practical ways to access commodities outside
the futures market are through commodity ETFs or commodity
stock ETFs. A commodity ETF represents the actual
underlying price changes of a commodity or material. Among
many choices there are commodity ETFs for oil, gold, silver
or blends of different commodities.
A commodity stock ETF invests in the stocks of commodity
producers rather than the underlying commodity itself. A
commodity stock ETF may represent gold miners, oil
producers or agribusinesses among others.
Both of these styles of ETFs carry risks as well as
benefits but which is the right choice really depends on
the reason why you are investing. If you are looking for
diversification the commodity stock ETFs may present a
problem. They will have a higher correlation to the equity
market in general.
If you are already invested in stocks, adding a commodity
stock ETF will add limited benefits because it tends to
move up and down with stocks in general. Alternatively a
commodity ETF will tend to move more independently of the
stock market over the long term.
The correct answer to which investment is best for your
portfolio is a matter of understanding the differences
between the two types of commodity investments and how it
relates to your objectives.
- Commodity Stock ETFs
spread the an investment among several stocks in the same
sector. For example, Market Vectors Agribusiness ETF (
) invests in a blend of stocks involved in the
production of agricultural products. These stocks include
), ADM (
) and Deere and Company (
). The fund is diversified among different stocks but the
fund as a whole is still highly correlated to the major
- Commodity ETFs
invest in either the actual commodity they represent such
as the SPDR Gold Trust (
) or in commodity futures. The price of these ETFs will
only be affected by the price of the underlying commodity
itself. Commodity ETFs typically have a much lower
correlation with the major stock indexes.
You can measure an ETFs correlation to a major stock index
to get a feel for how much diversification potential there
is. If an ETF has a statistical correlation of close to 1.0
it is going to go up and down with stocks. The lower the
statistical correlation in an ETF, the more effective it
will be from a diversification perspective. In the video we
will walk through two examples how how this evaluation can
be done and why it is important.
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