The Case for Investing in Commodities

Commodities can add another level of diversification to your portfolio.

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Platinum and palladium. Platinum is similar to silver in that it's considered both a precious and industrial metal that's found in a number of different products. It will generally trade at a fairly high price, says Lydon, because it has a rather strained production line. Currently, platinum is trading around $1,500 per ounce. Platinum and palladium are used extensively in the production of cars, primarily for catalytic converters, so their performance is fairly dependent on global car production and sales. While car sales in the United States have been lackluster, China saw sales of 1.2 million in August—up 56 percent from the previous month. That large of a number may not be sustainable, Brodrick says, but over time the growing Chinese middle class will begin to demand more luxuries like cars. And that bodes well for platinum and palladium. ETFS Physical Palladium (PALL) and ETFS Physical Platinum (PPLT) both hold the physical metals and track the spot price. Both funds were launched by ETF Securities earlier this year. Brodrick cautions that the funds trade at very light volumes and can be extremely volatile at times.

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Oil and natural gas. Lately, oil prices have been somewhat depressed because of a lack of demand during the global economic slowdown and a surplus of supply. "We're seeing this trading range between mid-$60s and $80 a barrel for oil, and we're probably going to continue to operate there for a while until the economies begin to look better," Lydon says. Investors can get access to spot oil prices through futures contracts with funds like United States Oil ETF (USO), but with prices trading in such a low range, Brodrick suggests that they consider alternatives. "There are investments you can make that pay you big, fat dividends, and I'm talking about pipeline companies and even some of the oil producers," he says. Oil pipeline company Buckeye Partners (BPL) and ConocoPhillips (COP) are two of his favorites. Buckeye Partners is currently yielding 6 percent, while ConocoPhillips offers a dividend of 4 percent. El Paso Pipeline Partners (EPB) is a natural gas play for investors that also offers a sizable 5 percent dividend.

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Agricultural products. Generally, commodities tend to be cyclical in nature. Christian Hviid, director of market strategy at Genworth Financial Asset Management, says his firm is expecting extremely slow growth in the United States going forward, and that means he's staying away from many of the more cyclical commodities like those in the energy sector. "Longer-term, we like commodities, but because of some of the cyclical forces, one needs to tread carefully around certain types of commodity exposures that are out there," he says. He currently favors agriculture. Hviid says products like grains and livestock generally have more constant demand. "Those areas tend to move less in terms of association of what the economy is doing because there is always demand for food," he says. Demand from emerging markets will drive commodity production in the future. The population in these countries is growing steadily, and as a larger middle class emerges in places like China, people there will begin to consume higher-calorie foods, Hviid says. Lydon recommends two ETFs for investors looking to invest in agriculture: PowerShares DB Agriculture (DBA) and Market Vectors Global Agribusiness (MOO). Both hold futures contracts for a variety of agricultural products.

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A little bit of everything. For many investors, checking the price of any single commodity on a consistent basis may be too complicated. ETFs have made investing in a single commodity easy, but they also offer investors the option to invest in a number of commodities within a single fund. Some advisers suggest a more diversified approach. "Our preference is to do it through a broad-based basket of commodities—not to try to pick and choose commodities," Miccolis says. Experts say this strategy can be a useful for investors who are wading into the sector for the first time. Miccolis says he has used a combination of mutual funds and ETFs in the past for his clients including Oppenheimer Commodity Strategy Total Return (QRAAX) and PIMCO Commodity Real Return Strategy. Lydon recommends iShares S&P GSCI Commodity-Indexed Trust ETF (GSG) or PowerShares DB Commodity Index Tracking ETF (DBC).