Step 90: Investing in Gold and Commodities

In the previous step we looked at how investing in Real Estate can be an interesting addition to your portfolio in order to spread your risk more and generate another new income field. In this step we will look at another way to diversify your investment portfolio which is through commodities and gold.

Investing in commodities

Commodities (or natural resources) are important for the stock market in two ways: firstly many companies rely on commodities. If you have any Coca Cola shares then of course sugar prices at some point affect Coca Cola profit and therefore share and dividend prices. For any shares you might have in big retail or fashion stores wool prices will affect these share prices at some point in the chain and many other companies might rely on such commodities as oil, copper, grains and aluminum.

Apart from their importance to the companies that trade on the market, commodities play another part on the market as they too can be invested in directly, just like shares and bonds!

There are generally two commodity classes:

• Soft commodities – cocoa, wool, cotton, wheat, rice, coffee etc. These prices can fluctuate a lot, especially when a shortage exists (think about a bad harvest for grains, rice, potatoes or coffee for example and how this can drive up prices). Apart from the weather, also a growing population as well as people’s eating patterns effect these prices.
• Metals – zinc, aluminum, copper. Prices are less volatile as their time takes much longer: a new mine takes much longer  to open and operate. It’s easier to predict how prices are affected, also if new technologies such as microchips are developed that require more or different metals.

Whereas shares and bonds tend to move together (when stocks go up, bonds usually go up and vice versa – although shares tend to be more volatile than bonds), commodities are not affected by the stock prices and often times move in opposite directions to the rest of the market. They are therefore an interesting addition to many portfolios as they can provide some stability when the market moves a lot.

When the market goes down in an economic recession, people want to invest in security which commodities provide – we all need to eat at the end of the day! – which drives commodity prices up. In reaction to this, more commodities are produced as more people see that farming or mining is becoming more lucrative. It can easily take a few years to set up a farming company or to start operating a mine however so the increase in demand leads to an increase in supply albeit delayed. Once supply starts to increase, prices go down again meaning that fewer people invest in commodities and fewer people pick up farming or mining, which leads to a reduction in the supply. The cycle is then repeated again and price, supply and demand are all factors that keeps this process in balance.

Investing in gold

Gold itself, unlike bonds (via interest), shares (via dividends) and real estate (via rental income), doesn’t produce an income. The price simply goes up or down. There are times when gold prices have done well and have gone up significantly, but there have also been long periods of time (such as for about 20 years between 1984 and 2004) where prices were pretty much flat or even going down consistently. So whereas gold can be a good investment and way to diversify, it doesn’t always prove to be a good option.

One of the mayor advantages of gold is that it does well when the market doesn’t do well – just look on the internet at “historic gold price chart” and see how much the price for gold soared following the 2008 crash. Investors see gold as a very safe investment that has been around for thousands of years and will be around for many more. When people are fearful about the market, they invest in gold as a “stable” investment.

As an investor you can either buy the gold and physically store it somewhere, or you can opt to invest in gold via the market. Of course anybody looking to physically own gold would need to think of safe ways to store it and insure it. Gold comes in ingots (the famous bars) or coins, and whereas there is of course gold in many jewellery items too, these are often over-valued and not worth investing in for their value. When investing in gold via the market you can do so via Gold ETFs (in which case you own gold but don’t need to worry about storing it) or alternatively by owning shares of mining companies, in which case you don’t so much invest in “the price of gold”, but mainly in the predicted profits the mining company will generate.

Although often referred to as “investing in gold” because that is what most people do, gold is part of a bigger investment category which are precious metals, which apart from gold can be silver, platinum, both of which tend to be more volatile than gold.

Step 90 – Investing in Gold and Commodities – in detail:

• As in the previous step, determine whether investing in gold and commodities is something that might be of interest to you.
• If you decide it is, like before, make sure to read up on this type of investment and do your homework in detail to find out more about the specifics and options.
• Once again, the above is only an introduction to investing in commodities and gold. Before taking it to the next level, make sure to educate yourself on the options, risks and costs associated.
• Investigate options to invest in commodities and / or gold and check the fees, conditions and small print as usual.

Like with real estate, commodities and gold can be an interesting way to further diversify your investment portfolio. With both gold and commodities, you will likely only hold a small part of your portfolio here, but it can provide that stability especially when the market experiences another recession.

Read more about my 100 steps mission to financial independence or simply decide to take control today and join us on our step-by-step quest on how to make your finances work for you, starting with step 1.