Commodities are goods characterized by uniform quality and utility, often interchangeable regardless of their source. From corn to wheat flour, these products are generally considered commodities as consumers typically don’t prioritize the brand or origin. Investors, however, usually focus on a specific group of globally demanded basic goods, often raw materials for manufacturing finished products.
Commodities are categorized into two main types: hard and soft. Hard commodities, obtained through mining or drilling, include metals like gold, copper, and aluminium, as well as energy products like crude oil, natural gas, and unleaded gasoline. On the other hand, soft commodities encompass products that are grown or ranched, such as corn, wheat, soybeans, and cattle.
Commodity portfolio
Diversifying market exposure is a key strategy for commodity traders, achieved through the creation of portfolios designed to reduce risk and serve as a hedging platform.
A commodity portfolio represents a collection of commodities, each assigned a specific weight. The age-old advice of “Don’t put all your eggs in one basket” underscores the importance of a diversified portfolio in the real-world context. Portfolio rebalancing not only allows traders to manage risk but also provides a platform for safer returns in the long run.
Commodities offer valuable diversification benefits to investment portfolios. By incorporating commodities and assigning them alongside traditional assets like stocks and bonds, overall long-term portfolio risk can be mitigated. The fluctuation in commodity prices, stocks, and bonds is influenced by market sentiment and economic conditions.
While adding commodities doesn’t guarantee protection against market risk at all times, historical data suggests that during neutral and negative periods for stocks and bonds, commodities may exhibit favourable performance, given the historically weak correlation between commodities and financial assets.
Gold or Crude oil:
During the period spanning from December 31, 2022, to December 31, 2023, significant shifts were observed in the returns of crucial commodities. Crude oil, denominated in USD, underwent a downturn, decreasing from 80.26 USD to 71.65 USD, indicating a negative return of 10.73%. Conversely, gold, also assessed in USD, exhibited a positive trajectory in its return, surging from 1,819.70 USD to 2,062.40 USD, signifying a gain of 13.34%. These divergent performances underscore the dynamic and multifaceted nature of commodity markets, where an array of factors influences the value and returns of distinct commodities over time.
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Conclusion
The trajectories of two prominent commodities, crude oil and gold, exhibited notable divergence. The analysis of the performance of these distinct commodities underscores the significance of diversification in investment strategies. The less correlated commodities, the higher the Sharpe ratio, emphasizing the importance of building a diversified portfolio. Investors should consistently prioritize diversification as a fundamental strategy to mitigate risks and enhance the overall stability of their investment portfolios.
Read: Utilising Commodity Markets As A Predictor For Cross-Market Strategies
