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Do Commodities Belong in Your Portfolio?

Do Commodities Belong in Your Portfolio?

The following is the sixth of a series of weekly articles in which Sheryl will provide overviews of investment options that offer alternatives to bank accounts. Last week's article covered annuities. As with any investment that's not an insured deposit account, there are risks. Some may feel that these risks are worth it for the chance of higher yields. The focus of these articles will be on conservative investments that may appeal to some savers who want a chance of higher yields and minimal risk.

Equities are far from the only investing game in town. Gold and other commodities, like corn, beef, oil and natural gas can have much appeal for not only the sophisticated investor, but the average Jane and Joe.

"Anyone can invest in gold and silver, regardless of income. We have clients who have begun accumulating precious metals through payroll deductions as little as $10 per pay period, alongside people who have invested over $1 million in gold and silver," says Josh McCleary, chief operating officer of Mass Metal, which has a service, SilverSaver.com, that connects individuals with direct ownership of physical silver and gold.

"Investing in commodities is much easier than it has been prior to the last decade. Prior to that period, you would need to invest in futures contracts in order to get exposure to commodity prices. While you could invest in companies that produced those commodities, direct exposure was only available via the futures market," says Kirk Chisholm, wealth manager and principal with Innovative Advisory Group.

These days though, in addition to the futures market, you can get access to commodities via Exchange-traded funds, Closed-end funds and Exchange-Traded Notes. Alternatively, there is the opportunity to invest in silver and gold coins or bullion.

So if you’re thinking of expanding your investing horizon to include commodities, here are some key considerations.

What You Need to Know

Investing in gold and commodities should be viewed as part of a balanced personal finance strategy, says Terry Hanlon, president of Dillon Gage Metals, a precious metals wholesale trading firm. "Gold and other precious metals for the most part, act as a ‘hedge’ against inflation and the stock market in general," he says.

Commodities offer diversity and is a hedge against dollar devaluation, says Donny Gamble, Jr., founder of Personalincome.org. One advantage too, he says, "Gold is a recognized world currency that can be exchanged all over the world.

historically, investors unknowingly pay high premiums on small quantities of hard assets

Andrew Carrillo, president and founder of Barnett Capital Advisors, says that if you’re buying gold as "insurance" to not worry about day to day volatility. "If gold is lower than it is today in 3-5 years, the retiree purchasing gold for insurance should be happy because what that tells them is that their pension payments are strong and they still have purchasing power. The largest risk for retirees is inflation, and gold can help hedge that risk. I expect gold’s outperformance of stocks over the last decade to continue the next few years as well."

However, be mindful that each commodity is its own creature. For example, "when the market is up, gold and silver tend to decline and vice-versa. But platinum and palladium, leveraged heavily in industrial usage, tends to mirror the fluctuations of the market," says Hanlon.

It’s essential to have proper knowledge about each commodity, along with historical trends and data. "Global economic development, technological advances and market demands for commodities can all have an influence on prices of staples such as oil, aluminum, copper, sugar and corn," says Gamble.

Hedge fund guru Damon Verial cautions against equating gold to silver. "Historically, they have shared a similar role, and their exchange rate has been pretty constant as far as commodities go. But gold and silver are different commodities."

While Hanlon and others may tout commodities as an "insurance policy" of sorts, don’t get it in your head that commodities are trouble-free. That’s hardly the case.

Keep in mind the facts.

"Commodities do not grow, multiply, pay interest or dividends. You can only profit from a favorable price change," says Jeff Born, professor of finance and executive director of the MBA program at D’Amore-McKim School of Business at Northeastern University.

Look at gold. The price of gold tends to move based on a few factors. One of the biggest is if the market senses an increase or decrease in credit risk in the financial system. "Traditionally, gold prices outperformed when real interest rates were negative (that is when price inflation is higher than base interest rates)," says Anthem Blanchard, founder and CEO of Anthem Vault. Other factors that move the price of gold include if the market anticipates a large increase in base money supply, price increases and decreases in core goods and services, and dollar strength and weakness.

Consider the tax implications. Gold is taxed at the collectible tax rate, rather than the long term capital gain rate.

Since there are many ways to invest in gold and silver, it’s important to research what’s the best way to own precious metals. "There is a difference between investing in commodities on the stock market – a "paper" ownership, which mimics the price of gold, versus direct ownership. Owning the hard assets give you the benefit of investing in gold, without taking on the risk of ‘owning’ digital assets that could ultimately disappear if there was a major issue in the market or the provider of a paper security," points out McCleary.

Direct ownership of gold and silver is a smart investment move if people know how to do it right, says McCleary. "You need to be cautious where you buy from, because historically, investors unknowingly pay high premiums on small quantities of hard assets."

If you decide to go for the gold, the experts share their wisdom. "Don’t invest in gold because you’re convinced that things are going downhill; invest in gold because it makes sense at the time (based on market sentiment and analysis)," says Verial.

Consider the tax implications. Gold is taxed at the collectible tax rate, rather than the long term capital gain rate.

If you buy physical gold in any large quantity, store it in a licensed depository, rather than in a bank or your home, says Hanlon.

Understand the liquidity options and associated costs of your gold investment vehicle of choice.

Finally, says Born, "Investments in precious metals and commodities are very high-risk. Limit your exposure to a small proportion of your total invested portfolio, 2-5% maximum. When I say very high-risk, be prepared to lose 100% of your investment – not quite as bad as going to a casino and parking a big bet on ‘red’ or ‘black’ at the roulette wheel, but close enough."

Editor's Note: For more viewpoints on gold investing, please refer to the CBS MoneyWatch article by Allan Roth, "Gold - My Best Investment Ever" and Clark Howard's article "Buying gold the Clark Smart way".

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Anonymous   |     |   Comment #1
"Commodities do not grow, multiply, pay interest or dividends. You can only profit from a favorable price change,"

I'd rather own raw land as an investment and inflation hedge rather than gold. At least I can have something built or grow something on it. With a home on land it can be rented out and supply a monthly stream of income. Also, the land may be leased for agricultural use which would supply additional income.
Anonymous   |     |   Comment #13
Good luck with that. 
DjD   |     |   Comment #16
Land has carrying costs, very high carrying costs (property taxes) in New Jorsey (not a typo).
Anonymous   |     |   Comment #2
I guess it was only a matter of time before a "buy gold article" showed up. If you want to lose a lot of money play the commodities market as an amateur. If you want Gold or Silver then buy coins, put them in a safe deposit box and pass them on quietly to your heirs. Secret information: the cashiers at your local stores will not accept most gold or silver coins as currency.
Anonymous   |     |   Comment #5
Have never seen any gold coins used as plain currency, but I do occasionally see silver coins.  And I never turned them down nor would I a gold coin, should it be tendered for face value as plain currency.
Anonymous   |     |   Comment #12
Except the article didn't say to buy gold. It talked about why you might want to and the risks. 
Anonymous   |     |   Comment #3
There is no safe investment no matter how you slice it. What if USA decides to issue new dollars where the gold is valued at $5 per ounce, what if the nations around the globe decide not to convert the gold into currency and punish the rich, just look at UN nations salivating on money they do not own?
To far fetched, if that was that easy, everyone will get paid in gold coins and the value will plummet when everybody will try to converted back into currency, after all, you can not buy bread with gold.
I;m not saying gold does not have its place in everyones portfolio, but classify it as safe is not true.
Anonymous   |     |   Comment #6
One country alone does not set the value of gold.  In the example given, the USA currency is what would be dealt a severe blow.

I do agree there is no guaranteed safe investment. 
Anonymous   |     |   Comment #7
The gold is treated as commodity and not as currency, therefore, every time something goes wrong or good with the currency that is quoted in, the gold is vulnerable, the gold will suffer a lot if USA's interest rates go back to normal or above, the gold does not pay interest and may depreciate in value over a long time.
Many of you remember the gold price above $1800/oz and gold down to $350/oz not long so long ago.
Such a wild swing, is indication of volatility and not something you want to hold on for long time.
Anonymous   |     |   Comment #9
Agree, the price of gold as well as any other commodity is can be very volatile.  Oil is another example of price volatility.  However, it's a world market.  Not one country along controls the price.
Anonymous   |     |   Comment #14
So what are the options? Horde cash under your mattress? You have to take some risk to make money. 
Anonymous   |     |   Comment #18
Have you looked at 5, 10, 15, 20, 25, etc. stock market charts?
Anonymous   |     |   Comment #17
Gold is a COMMODITY, not a currency.
Anonymous   |     |   Comment #4
      I Trade in Silver and try to accumulate Gold,though the tax,here in India is very high on both.I have found that in Bull Markets Stocks give good returns.But Gold and Silver saved me from the 2008 crash and later.
      I find Gold and Silver,both PHYSICAL SUPERIOR,especially in the coming days,as there is going to be a lot of UNCERTAINTY politically and economically.   
Anonymous   |     |   Comment #8
You have to be psychic to know the crash beforehand to protect yourself, if that is the case, congratulations, if not, please look at this chart:

Scroll down to see the rest of it.
Anonymous   |     |   Comment #15
If you type it out in capital letters it must be true. 
decades   |     |   Comment #10
Really tempted to start nibbling on some crude here at these levels , gas now below $2.00/gallion http://finviz.com/futures_charts.ashx?t=CL&p=w1
Anonymous   |     |   Comment #11
I have been short oil (USO) since oil was at 85/brl. I am thinking about covering my short and take a long position averaging down to < 30/brl.
Rosedala   |     |   Comment #19
As usual, most interesting and helpful indeed! Thank you! 

Not to change the subject but...in lieu of “seeing the face behind the post” here, it would mean so much if at least a name was shown, even a silly nickname...which won’t compromise your privacy in the least....Thank you.  Continue with the interesting subject now.   :o)
gregk   |     |   Comment #20
"The focus of these articles will be on conservative investments that may appeal to some savers who want a chance of higher yields and MINIMAL RISK." (from the series introduction).

Finally, says Born, "Investments in precious metals and commodities ARE VERY HIGH RISK.  When I say very high-risk, be prepared to lose 100% of your investment..." (quoted from expert consultant for the column Jeff Born).
Anonymous   |     |   Comment #21
If gold and silver are so wonderful........why do all these companies want to sell it to you? According to them it's going to shoot up in price. If they are so sure of that.......I would think they would buy it and hold on to it.
paoli2   |     |   Comment #22
That's exactly what I keep thinking everytime I see one of those gold and silver commercials.  Why sell it today at a lower price when it's going to cost so much more in the future!  One would think they would be hoarding it for themselves which they may already be doing.  Frankly, I prefer silver  numismatic coins which are valued for more than just their silver value.
Anonymous   |     |   Comment #23
That is just what I told a saleswoman who called me with a sales pitch to purchase gold from the company she worked for,  just before I abruptly hung up on the cold caller.