Though it was a spoof about greed and riches to rags in high stakes commodity trading, there were many grains of truth sprinkled throughout the movie.
Commodities, be they pork bellies, orange juice futures, or oil, have always been a risky game. In some ways it’s odd because this sector includes real stuff – what we eat, drink, use for heat, build with and buy to adorn ourselves. High tech, in comparison, is crammed full of ephemeral ideas, companies with no revenue and technology so complex it’s very hard to separate fact from fiction.
But the commodity sector, like technology, is massive and includes everything from solid and stolid blue chips to here-today-gone-tomorrow penny stocks. Within the sector you can find investors, traders and gamblers.
We tend to consider investing in commodities when the bottom falls out. You missed getting in on $140 a barrel oil so why not now when the price hovers around $60? And what about gold? It looks cheap at just over U.S. $1200 compared to 2011 when it topped $1800.
Before you leap, take note that those price moves say something important about commodities in general. The entire sector is highly cyclical and ultra-sensitive to economic and global conditions. Recessions bring out the gold bugs. Boom times attract buyers of resources such as copper and other metals important to construction. Droughts or floods in one part of the world usually spell high prices for commodities such as wheat and corn in unaffected regions.
But the correlation between what is going on in the world and how commodities behave is far from exact. The United States economy is pulling out of a deep recession, which should mean higher demand (and higher prices) for oil and related products. However, at the time this article is being written, the price of a tank of gas makes it clear that the relationship isn’t holding true — so far.
Predictions about commodity prices are littered with more misses than hits – I haven’t yet found anyone who predicted the evisceration of oil prices. Softening, yes. Meltdown, no. So, if the experts rarely get it right, should average investors leave this high-risk sector to the gamblers? Not at all.
If you own a big company Canadian mutual fund or a broad-based exchange traded fund (ETF) you almost certainly are invested in commodities. The S&P\TSX Index has an over 21 percent weighting in energy alone. Add in the material sector, which includes metals, and your commodity investment could be as high as 34 percent with just a single holding.
The big issue for Canadian investors is not so much should one invest in commodities, rather how to ensure that commodities don’t comprise too much of a portfolio. Money managers tell me that 10 percent is a safe number for most investors.
The easy solution is to diversify. Simply adding fixed income and U.S. holdings dilutes the commodity focus. Energy and materials comprise just under 12 percent of the S&P 500 index, for example.
Commodities are a vital part of our world but for investors, they’re a bit of a hot potato. Before adding any commodity holding, be it a mutual fund, stock, or ETF, take a look at your portfolio. You may already have more than enough invested in this sector.