I recently was with a good friend of mine who is a retired finance professor. Prior to teaching at Temple University, he had a career as a stock trader at a big investment house. While we were talking, he was constantly looking at his cell phone. After a while, I asked him what was so interesting on his phone. He told me now that he was retired, he was trading commodities. Wow, I said, have you made any money? Not yet, he replied.
Commodities are generally unprocessed goods used to make other things. They do not have a dividend as stocks and bonds do, so the only return is its increase (or decrease) in value. Here are some examples:
- Grains (wheat, corn, soybeans)
- Metals (gold, silver, copper)
- Meat (beef, pork bellies)
- Oil
- Natural gas
- Foreign currencies
Commodities prices are determined by the interaction of supply and demand in the marketplace, and they are often subject to large price swings. Droughts increase the prices of grains and meats. The fracking of oil and natural gas in the U.S. caused a dramatic drop in the world price of oil and gas.
Gold is somewhat special in that its only practical use is for jewelry, but it is seen as a store of value in good and bad times. Investors turn to it for safety when the stock market drops (especially during recessions). Likewise, when bond returns decline, safe asset investors turn to buying more gold, increasing its price. When inflation accelerates, the price of gold tends to rise, because it takes more dollars to buy an ounce of gold. Gold’s price gyrates; when there are wars, natural disasters or recessions, it increases in value and vice versa. However, it does not evidence huge returns over time. For example, during the Great Recession, stocks dropped 30% but gold only rose 5%. When stocks roared back over the next couple of years, gold did not rise much at all. However, the performance of gold in the Pandemic Recession has been extraordinary. It has increased 25% since the beginning of 2020. I believe we can attribute this to the amount of fear and uncertainty caused by the Pandemic, since the price of gold always reacts to fear. See the graph below for the price of gold since 1970. The big spikes are in recession years.
Figure 13.10. Gold Price by Fred Rowland is used under a CC BY-NC 4.0 License. Source: Yahoo Finance data (11/30/2020).
Because of their volatility, commodities are a risky investment, and you should consider them like betting on a roulette wheel at a casino. Many factors outside of your control affect the price of commodities.