Role of Commodities in Portfolio Diversification: A Smart Investment Strategy

Retail investors need to acquaint themselves with some key strategies for market-linked investment instruments like equity stocks and commodity assets. One such strategy is closely connected to the role of commodities in portfolios. So, if you think you have a robust investment portfolio, we suggests that you take a better look at it and seriously consider adding diversity. This is because the role of commodities in portfolios is such that they can serve as a safety net that minimises your losses during a bearish market.

Strategic Benefits for Individual Investors

The main reason you should include commodities in your portfolio is that the role of commodities in investment portfolios is quite multifaceted.

Investment Risk Management

Firstly, the role of commodities in investment portfolios is such that they can help you manage risks from your other assets like equity stocks. This is because commodities like oil and gold often have a negative correlation to equity stocks.

For example, when an equity stock in your portfolio underperforms, there is a high chance that a gold bond in your portfolio might overperform, thereby compensating the difference and reducing your overall losses.

In fact, Sovereign Gold Bonds (a type of commodity asset) are so popular as risk management instruments that in February 2024, Indians purchased a total of ₹8,000 Crore worth of these bonds.

Hedging Against Inflation

Another important role of commodities in investment portfolios is serving as hedging instruments against inflation. If you are looking to mitigate against the negative effects of inflation in your portfolio, then adding a few commodities to it is a good start.

The main reason for this is that commodity assets that track prices of commodities like gold tend to match the rates of inflation. Since these are commodities also sold on the market, their growth matches that of market inflation.

For example, if the value of equity assets in your portfolio is downward due to inflation, you can buy some gold bonds to compensate for the losses. So, the role of commodities in portfolios is such that they provide a soft cushion that effectively reduces your net losses during inflation.

Exposure to Global Economic Growth

The prices of commodities like crude oil and precious metals (like gold) are often linked to the growth of the global markets. Due to the chain of demand and supply, there is a continuous price appreciation of these commodities globally.

This direct link to the global economy offers you a taste of the global markets if you choose to purchase commodity assets like crude oil and gold. The role of commodities in portfolios is, therefore, much more than a way to diversify. They are the windows that expose you to global economic growth.

How to Invest in Commodities

If you are looking to benefit from investing in commodities, then here are three ways to do so.

1. Investing in Commodity Futures : You can buy commodity futures contracts that give you the right to buy or sell a particular quantity of the said commodity at a predetermined price and date in the future. You can easily engage in futures trading using trusted online trading platforms like HDFC Sky.
2. Investing in Commodity ETFs : You can also purchase Commodity Exchange-Traded Funds. These commodity-focused exchange-traded funds (ETFs) can help you further reduce overall risk. This is possible because commodity ETFs invest in a combination of different commodities.
3. Investing in Companies Dealing with Commodities : On the other hand, you can always invest in the equity stocks of companies that directly deal with commodities such as crude oil and gold. So if the prices of these commodities go up, then depending on the company’s usage of the commodity, its stock prices can go up or down.

Understanding Risks and Challenges of Investing in Commodities

While the role of commodities in portfolios is quite significant, there are some risks and challenges that need to be understood.

• Commodity prices are highly volatile.
• They are dependent on numerous external factors.
• Different commodities have different characteristics which need to be studied before investing.

By staying alert to these risks and challenges and commodity market trends, you will be able to make the right decisions when trading in commodities.

Conclusion

So, if you are looking for sustainable portfolio diversification strategies, then the role of commodities in portfolios is something you must not forget. By purchasing commodities, you can ensure to some extent that the losses from other asset classes would be compensated for by the unwavering growth of commodities like gold.