Commodities are essentially market traded goods which are not distinguished by qualitative factors. In other words the commodities are not distinguished by who supplies them. Whether it be a barrel of oil from Texas or Dubai, the price is still the same as set by the market.
One of the fundamental characteristics of commodities, is that they do not produce an income stream. They are purely assets which increase or decrease in value. Holding commodities within a portfolio can add diversification and help reduce investment portfolio volatility. It would be normal for commodities to play only a small part in an investors overall portfolio.
Commodity Price Indices
The main measurement of commodity market price movements, are through the use of commodity market indices. These indices track the price movements of a basket of commodities and are weighted according to the components of the index in question.
Some of the main commodity indices are:
- Rogers International Commodity Index – RICI.
- Dow Jones AIG Commodity Index
- Standard & Poors Commodity Index
An example of the makeup of one of these indices:
- Natural Gas (17.65%)
- Unleaded Gas (12.16%)
- Heating Oil (12.13%)
- Crude Oil (11.41%)
- Wheat (5.15%)
- Live Cattle (4.87%)
- Corn (4.48%)
- Coffee (3.88%)
- Soybeans (3.84%)
- Sugar (3.80%)
- Silver (3.67%)
- Copper (3.39%)
- Cotton (3.22%)
- Soybean Oil (2.98%)
- Cocoa (2.79%)
- Soybean Meal (2.57%)
- Lean Hogs (2.04%)
As can be seen from this list of components Oil and it’s byproducts make up a majority portion of the main commodity price indices. So movements in the price of Oil will have a large impact in the overall price movement of the index.
Also, it should be noted. As most of the base pricing for commodities is in US dollars, foreign exchange movements of euro against the dollar will be reflected in the euro investor’s gains / losses.
Investors can access commodities, through exchange traded funds (ETF’s) which track a commodity index. Another way to gain exposure to commodities is to hold shares in a company which is operating in the commodity sector, such as oil exploration companies. The most common way of investing in commodities is through a managed fund or through an investment bond.