The Case for Investing in Commodities

Commodities can add another level of diversification to your portfolio.

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Diversification is one of the most important rules of investing. If you invest in a range of different asset classes, such as stocks and bonds, losses in one may be offset by gains in another. Investing in commodities—whether it's oil, gold, or pork bellies—is yet another way to achieve broader diversification.

"We believe they have a role in just about every client's portfolio—aggressive, conservative, or anything in between," says Jerry Miccolis, coauthor of Asset Allocation For Dummies and principal and chief investment officer of wealth management firm Brinton Eaton. "The reason is that they typically zig when the more traditional investments zag."

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Many advisers recommend commodities funds to their clients, in part because it's easier than ever to invest in commodities. The emergence of investing options like exchange-traded funds has made what was once an exotic asset class more accessible. "Commodities are now more broadly recognized as an asset class that investors and advisers have access to, and everybody is trying to figure out how much they should allocate to them in their portfolio and in what form," says Tom Lydon, editor of ETFTrends.com.

For many investment advisers, the case for commodities goes further than diversification. Commodities are commonly used as a hedge against inflation, which some experts say could become an issue over the long term. Rapidly growing emerging economies including China and India will increase demand for commodities as well. Some advisers recommend a portfolio allocation of between 5 and 10 percent to commodities, depending on clients' investing time horizon and risk tolerance. It's important to be cautious, though, as commodities can be an extremely volatile asset class.

U.S. News spoke with a few investment experts about how to incorporate different commodities into a portfolio in today's market:

Gold. In recent weeks, gold has soared to historic highs of more than $1,250 per ounce. Historically, the precious metal has benefited from volatility in the stock market, as investors get spooked and seek safety. SPDR Gold Shares ETF (ticker GLD), which holds actual gold bullion in underground vaults and tracks the spot price, has seen its net assets skyrocket to more than $50 billion since its 2004 inception—making it the second-largest ETF behind SPDR S&P 500 ETF (SPY). Depending on who you ask, gold could be poised for an even bigger run-up, or just the opposite. "If we saw $1,400 gold by Christmas, that wouldn't surprise me," says Sean Brodrick, small cap and natural resources analyst for the blog Uncommon Wisdom Daily. Brodrick believes gold could reach $1,600 an ounce sometime in 2012. Others aren't so sure.

Lydon points to a different route to access the yellow metal: stocks of gold mining companies. "Even if gold stays flat from this point going forward, these companies are going to continue to be very, very profitable," Lydon says. "If you've missed the gold trend at this point, consider the metals miners." Lydon recommends Market Vectors Gold Miners ETF (GDX), which holds gold mining companies throughout the world.

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Silver. Often referred to as the "poor man's gold" because it generally trades at a lower price, silver has been on its own rally of late. The metal recently closed at more than $20 per ounce, a level not seen since March 2008. iShares Silver Trust ETF (SLV), which holds physical silver bullion and tracks the spot price, has outperformed its yellow counterpart, SPDR Gold Shares, so far in 2010. Year-to-date, the funds have returned 17 percent and 13 percent, respectively. Experts say silver has benefited from more than just uncertainty in the market. "It plays both sides of the fence," Lydon says. "It's not only a precious metal that's used in jewelry—and that has the same types of demand [as gold]—it's also used as an industrial metal." As the global economy recovers, Brodrick believes there may still be some upside for silver because it's used in a range of products, including LCD TVs and microprocessors.