Quick Explainer, Commodities

Stocks and bonds don’t offer access to everything. Investors may want to own the physical inputs that power the economy. This category is called commodities.

Our definition for commodities is:

Commodities: A broad category of physical raw materials and agricultural products typically traded via futures contracts. Commodities are commonly grouped into segments such as energy (crude oil, natural gas), metals (gold, silver, copper), and agriculture, which includes grains (corn, wheat, soybeans) and softs (cotton, sugar, coffee, cocoa).

Stocks are an ownership stake in a company. Bonds are debt, either from a government or company. Commodities are entirely different. They are raw physical goods, primarily traded with futures contracts.*

Commodities tend to respond to physical supply-and-demand factors like weather and geopolitical conflict. This is why they have historically had a low-correlated* relationship with debt and equities. This independence from traditional portfolio assets is part of the appeal and why they’re used as a portfolio diversifier and risk management tool by managers.

Some commodity classifications include livestock (cattle, hogs) as a separate segment, often grouped with agriculture or treated on its own. The classification depends on the index or framework being referenced.

Inflation* hedging is one of the most common use cases for commodities. Historically, some commodities like precious metals have performed well during inflationary periods. As prices rise and purchasing power declines, investors have found that commodities like gold and other metals have preserved their value. They have tended to show less severe drawdowns during inflationary periods, with occasional appreciation that has outpaced the rate of inflation. 

Another reason to hold commodities is their different economic cyclicality. They don’t historically align with equity or debt cycles and are driven much more exogenously. Agriculture is influenced by weather and crop cycles. Metals are influenced by manufacturing and construction cycles. Energy responds to global growth cycles in addition to geopolitical shocks. All of these disparate factors add to the potential diversification benefit for portfolios.

One important factor when investors consider commodities is how they can get exposure in an effective way. There are three standard tools that can be used and each has a different use case.

Holding commodities adds complexity. The prices can be volatile, access can be tough to dial in, and returns can be varied. The aim is to have a portfolio that can perform across different market cycles and conditions and for that complexity is required.