What is a Commodity?
Commodities are standardized raw materials traded on exchanges worldwide. They fall into four categories: energy (crude oil, natural gas), metals (gold, silver, copper), agriculture (wheat, corn, soybeans), and livestock (cattle, hogs). Gold has been a store of value for millennia - its price rose from about $35 per ounce in 1971 to over $2,000 by 2024. Crude oil, the most actively traded commodity, sees daily trading volumes exceeding $100 billion.
Commodities as Portfolio Diversifiers
Commodities have historically provided a hedge against inflation because their prices tend to rise when the general price level increases. During the high-inflation period of 2021-2022, the Bloomberg Commodity Index gained over 25% while both stocks and bonds declined. However, commodities produce no income - unlike stocks (dividends) or bonds (interest) - so long-term returns depend entirely on price appreciation. Over 30-year periods, commodities have returned roughly 3-4% annually, barely keeping pace with inflation.
Key Considerations
Most investors access commodities through ETFs or futures-based funds rather than physical ownership. Futures-based commodity funds suffer from contango - a condition where future prices exceed spot prices - which creates a drag of 2-5% annually as contracts are rolled forward. Gold ETFs backed by physical bullion avoid this issue. A typical portfolio allocation to commodities is 5-10%, primarily for inflation protection and diversification rather than growth. Individual commodity prices can be extremely volatile, with oil swinging 30-50% in a single year.