Commodities: Look Before You Leap

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As worrisome signs about inflation and the strength of the global economy have been dragging down the broad market, commodities, energy, and basic-materials securities have been a rare bright spot. For the five years ended 16 July, the S&P/GSCI Commodity Index gained 16% per year on average, versus a 9% gain for the FTSE All Share and a 6.7% rise for MSCI World.

With growth in emerging markets continuing apace, it's easy to assume that demand for commodities such as oil, metals, and food products will march inexorably higher, too. It's also tempting to want to position your portfolio to benefit from price gains in commodities. If you're going to have to fork over more cash to fill up your petrol tank and your kitchen cupboards, why not try to earn back at least some of those extra costs by owning commodities or the companies that sell them?

So, should you join the throngs flocking to energy and commodities? Recent returns have certainly been scorching: As worrisome signs about inflation and the strength of the global economy have been dragging down the broad market, commodities, energy, and basic-materials securities have been a rare bright spot. For the five years ended 16 July, the S&P/GSCI Commodity Index gained 16% per year on average, versus a 9% gain for the FTSE All Share and a 6.7% rise for MSCI World. Further, there is little performance correlation between commodities and major indexes--the FTSE All Shares correlation with the S&P/GSCI Index over the past 5 years is just 0.14, a minuscule level (1 would indicate perfect correlation; for context, the All Share has a correlation of 0.89 with the MSCI World index). So, commodities clearly are a worthwhile diversifier as a small part of a long-term portfolio.

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