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Why Invest in Commodities? Diversification and Inflation Protection

Commodities are “real assets,” unlike stocks and bonds, which are “financial assets.” Commodities, therefore, tend to react to changing economic fundamentals in ways that are different from traditional financial assets. For example, commodities are one of the few asset classes that tend to benefit from rising inflation. As demand for goods and services increases, the price of those goods and services usually rises as well, as do the prices of the commodities used to produce those goods and services. Because commodity prices usually rise when inflation is accelerating, investing in commodities may provide portfolios with a hedge against inflation.

By contrast, stocks and bonds tend to perform better when the rate of inflation is stable or slowing. Faster inflation lowers the value of future cash flows paid by stocks and bonds because those future dollars will be able to buy fewer goods and services than they would today.

Finally, in addition to providing enhanced diversification and a potential hedge against inflation, commodities may also offer investors a hedge against “event risk,,” or the risk that a financial crisis, war or another geopolitical event could cause other asset classes to lose value.

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