In the previous sections, you have gained an understanding of the commodities market. Let us now focus on the benefits of commodity investment.
Throughout the world, investors see commodities as a vital component of well-balanced investment portfolios. This is partly because the returns on most commodities have exceeded inflation rates in the last 60 years. So, you can beat inflation by investing in commodities. It is a good option even if you are a passive investor who does not buy or sell frequently.
Here are some other key benefits of commodity investment.
Commodity futures trade on margins. To meet the margin requirements of the exchange, you deposit a small fraction of the contract value with your broker. With this margin, you can make bigger trades than your resources permit. Bigger trades give you an opportunity to earn higher returns.
Commodity futures trade on exchanges. So, there is always an active market where you can buy and sell commodity futures in any quantity. That would not be possible for assets such as real estate, which do not trade on exchanges. After all, it may take you years to buy or sell a property. By the time you find a seller or a buyer, the prices may have changed drastically.
Commodity futures are excellent for portfolio diversification. That is because commodities have a low correlation with other assets (e.g. equities). For example, gold prices have historically shown low correlation with the prices of most other assets. As such, gold is great for diversifying your portfolio.
Hedge against inflation
Inflation refers to an increase in prices. It is often the result of an increase in commodity prices. Since commodity prices frequently determine the inflation rate, commodity investments can help you to ride the inflation wave.
Besides its ornamental value, gold is a great store of wealth for the future. Owning a reasonable amount of gold jewellery is fine. But holding large amounts of gold bullion can be risky.
Commodity futures allow you to buy and sell as much gold as you like in the dematerialised form. This means you can own any amount of gold, but you do not have to hold it physically. The value of your gold reflects in your Demat account. But the actual gold is stored safely in a deposit vault approved by the exchange. There are four advantages of holding gold in this way.
Many brokers also offer a full package of services with physical gold contracts. They may even work as commission agents to take care of sales tax or VAT issues on your gold.
Commodities traded in commodity exchanges
Many commodities trade on commodity exchanges around the world. These commodities can be classified based on their use and consumption or their characteristics.
One way of categorising commodities is into four groups: foodstuff, industrial metals, precious metals, and energy. Some commodities that fall under each of these groups are given below.
In the next chapter, we will take a further step in our exploration of the commodities market. Our focus will be on the two types of futures markets: the normal futures market and the inverted futures market.