The Various Pro's and Cons of Commodity Investing

Like any financial instrument, the risk inherent is determined by the knowledge and subsequent implementation of the investor’s strategy. Thus although Commodities as a single financial instrument are quite volatile, they offer lots of diversification potential due to their low covariance with other instruments and this results in taking this high volatility and converting it to aid a largely risk adverse investor the opportunity to achieve his specified low level risk

If an investor holds commodity’s on their own then he is largely susceptible to its large volatility caused by the speculative nature of commodity traders. These speculations are very much short term’s creating possible large losses if not assessed correctly. Another risk that this single instrument investor would face is that of political risk and its very much “unpredictable nature” that is associated with it. These commodities are often located in very unstructured Countries and therefore there is often a tendency for some sort of political risk to be involved in their prices. The problem with this political risk is that it is often magnified on the downside, meaning that when the political relationships are looking good, it affects the commodity prices upwards marginally but when political destruction takes place it would often cause the commodity prices to spiral out of control.

However analyzing a single investor cannot draw inferences about the risk profile of commodities as the majority of serious and well educated investors don’t just hold one class of financial instruments. With this being said, Commodities are largely negatively correlated with the majority of stocks and bonds and thus can diminish the risk that is associated with these two instruments. There are 2 main reasons why this correlation is low and allows us to draw inferences about its true risk nature. T

he first opportunity that the trading of commodity’s can give a risk adverse investor is the opportunity to hedge...