Hot Commodities

Commodities are up double digits this year.

The reason is that the market is pricing in inflation. And commodities are the ultimate inflation trade.

They also give you exposure to the weaker dollar and higher deficits.

If there is any time to be long commodities, this is it.

The good news is, it's easier than ever to own them.

Why Commodities, Why Now?

Commodities are stuff that we use. Things like corn, wheat, soybeans, oil, natural gas, copper, lead, tin, coffee, cocoa, cotton, and sugar.

They don't produce any cash flow. Businesses do, which makes owning stocks more attractive.

Plus, commodities are expensive to hold. You have to pay money to store them. It's like a negative interest rate. So why have them?

Because they are uncorrelated to other things in your portfolio.

The vast majority of people with a portfolio have stocks and bonds and nothing else.

Inflation is theoretically good for stocks. But it's bad for bonds, and you've seen bonds getting killed recently. This is the inflation trade at work.

How to Invest in Commodities

In the 1990s, you had to buy individual commodity futures, and that meant using margin. Risky stuff.

In the 2000s, commodity exchange-traded funds like the iPath Bloomberg Commodity Index Total Return ETN (DJP), which tracks the Dow Jones-UBS Commodity Index, appeared. ETFs helped to make commodity investing more accessible to more people.

You can use gold in place of a basket of commodities. It gives you exposure to a weaker dollar, inflation, and deficits. You also get a hard asset that is a store of value. And that's true whether you invest in gold stocks, ETFs, or the physical metal itself.

What Makes Them Valuable?

You can print dollars—and we have printed trillions of them in the last year—but you can't print commodities.

You can create more gold by mining it… you can drill for oil, grow corn, harvest coffee beans… but you can't print them on demand.

Like stocks, commodity prices are driven by supply and demand. But unlike stocks, commodities tend to go down over time.

The reason is human progress. Crop yields improve. Companies get more efficient at mining or drilling for oil. As a result, people can often get commodities more cheaply over time. It's only when human progress goes in reverse that things get more expensive.

Even though gold is down 10% this year, I won't think about selling mine until the government starts becoming interested in decreasing the deficit. Probably not even then.

That's because just having stocks and bonds is not diversification. Commodities will help, but even that's not enough. To learn more about how to build a fully diversified portfolio, click here.

Jared Dillian
Jared Dillian