What are commodities?
Commodities are raw materials used to create the products consumers buy, from food to furniture, to gasoline or petrol. Commodities include agricultural products such as wheat and cattle, energy products such as oil and natural gas, and metals such as gold, silver, and aluminum. There are also “soft” commodities, which cannot be stored for lengthy periods, including sugar, cotton, cocoa, and coffee.
The commodity market has evolved significantly from the days when farmers hauled bushels of wheat and corn to the local market. In the 1800s, demand for standardized contracts for trading agricultural products led to the development of commodity futures exchanges. Today, futures and options contracts can be traded on exchanges around the world on a huge array of agricultural products, metals, energy products and soft commodities. These standardized contracts enable commodity producers to offload their price risk to end users and other financial market participants.
Commodities have also evolved as an asset class since the 1990s, with the development of commodity futures indexes and subsequently, investment vehicles that benchmark against these indices. Today investors can choose from a variety of vehicles for investing in the commodities futures markets, from mutual funds to exchange-traded funds or notes, covering the wide spectrum from single commodity exposures to sector based and broad-based commodity exposures.
Why invest in commodities?
Investors typically consider a commodities allocation to provide three key benefits to their portfolios:1) inflationhedge; 2) diversification; and 3) return potential.
Inflation hedge
Because commodities are “real assets,” they tend to react to changing economic fundamentals in different ways than stocks andbonds, which are “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.
In 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 that future cash will be able to buy fewer goods and services than they would today.
For these reasons, returns from a broad and diversified commodity index such as the Bloomberg Commodity Index, UBS Prompt Commodity Index or the S&P Goldman Sachs Commodity Index, have historically been largely independent of stock and bond returns, but positively correlated with inflation.
Between 1990 and 2024, annual returns on the Bloomberg Commodity Index had a low correlation with U.S. equities, as represented by the S&P 500 Index, and a correlation close to zero with global bonds, as represented by the Bloomberg Global Aggregate Index. However, they had a high correlation with the U.S. Consumer Price Index.
