Gain Practical Knowledge of Commodities

Physician's Money Digest, November15 2003, Volume 10, Issue 21

Most physician-investors are familiar with the general terms and investment guidelines associated with traditional stocks and bonds. However, when it comes to commodities and the investment opportunities they offer, many investors aren't aware of the basic guiding principles associated with investing in this arena. The following information should help you gain a better understanding of the commodities market.

Historical Perspective

Commodities are articles of commerce, such as foreign currency, financial instruments, indexes, petroleum, metals, and even agricultural products. Established in the same fashion as stocks and bonds, commodities first appeared on the financial scene in the 19th century. During this period, farmers and producers were continually plagued by wildly fluctuating prices. As the West grew, production from new ranches and farms increased, flooding the market with production and making prices unpredictable.

The Language of Commodities

The Irwin Guide to Using the Wall Street Journal

According to (New York Institute of Finance; 1985), to better control the wide swing in prices, "consumers" and "producers" began contracting the "buying and selling" of commodities at predetermined prices and delivery dates. Standardization paved the way for commodity success. As (McGraw-Hill Trade; 2000) points out, "Commodity contracts were standardized with respect to quantity, quality, delivery date, and price so that they could be traded."

Modern Commodities

Today, commodity contracts are settled at the initial "agreed to" price, regardless of market fluctuation. These contracts both limit the risk and reward of commodities. For example, let's say the current market price of a bushel of corn is $3 and you contract to sell your bushel for $3 during a specific period of time. If the market falls to $2 during the period specified in your contract, you will not lose the extra $1. However, if the market price of a bushel of corn increases to $4, you will not benefit from the $1 profit.

Properly allocating stocks, bonds, and diversification instruments within your portfolio can successfully lower its volatility and possibly improve annual returns. As money managers continually search for portfolio diversification possibilities, commodities, which are also referred to as "futures," have moved into the spotlight. It is important to understand, however, that you can't directly hold actual futures in an IRA. In fact, these contracts must be held in funds within your retirement portfolio.

Possible protection:

Many of the programs today that engage in trading futures "forward" and "swap" contracts. Because these funds can hold either long or short positions, they have the potential to profit or lose in a rising or falling market. In the past 3 years, many funds holding commodities have shown noticeable growth. Commodity futures can potentially provide a safeguard against political and economic instability, as well as natural disasters that affect supply and demand alliances.

John Valentine specializes in portfolio management and in developing high-net-worth strategies. He is the principal investment advisor at the Valentine Capital Asset Management of San Ramon, Calif. He welcomes questions or comments at 925-275-0200, or visit www.vcrpg.com.