Commodity prices are trading at near all-time lows. Crude oil has dropped from more than $100 a barrel a year ago to around $45 today. And the prices of several other commodities are also lower than they've been in years. 

The price of copper hasn't been this low since 2008 and the value an ounce of gold has dropped from nearly $2,000 to around $1,100, its lowest level in five years. The GSCI Index, which tracks the prices of commodities ranging from metals to energy, is trading at its lowest level since it was created in 2007, and is down almost 43% over the past twelve months.

Investors can get direct exposure to commodities via futures contracts or by buying ETF​s that track commodities. For example, the iShares GSCI Commodity-Indexed (GSG) tracks the GSCI Index. (See also: How to Invest in Commodities.)

Part of the reason for the depressed prices is that more efficient production and extraction processes have led to a glut. Decreased demand from Asia is also a factor, as the Chinese economy has begun to falter. Depressed commodity prices may be cause for caution, or they may signal a rare opportunity to add this important asset class to your portfolio. Here's why commodities can should be part of any well-rounded investment plan. 

Commodities Can Be a Hedge Against Inflation

Inflation is when the price level of all things rises, effectively making currency less valuable. Traditionally, certain commodities have been a hedge against inflation, protecting the purchasing power of an investor. Storable commodities such as metals (e.g. copper) and precious metals (e.g. gold, silver, palladium, etc.) have historically done well during times of inflation. Other commodities, however, have no correlation with inflation and will not protect against rising prices. Consumable, non-storable commodities such as food & agricultural products tend to be poor hedges against inflation. While oil was a good hedge against inflation during the oil crisis of the 1970s, it proved to be a poor hedge in other periods. Surprisingly, coffee has proven to be an effective hedge against a falling dollar.

Inflation levels have been quite low worldwide following the Great Recession. But that may not remain the case forever. If inflation picks up in the future, holding precious metals or coffee futures may be a bargain that will pay off.

Investors can gain exposure to Gold with the ETF ticker: GLD, Silver via SLV, or oil with USO. There is also an ETF which tracks the price of coffee: the iPath Bloomberg Coffee Subindex (JO). (See also: Seek Commodities to Hedge Against Inflation.)

Commodities Can Diversify Portfolios

While some commodities can show a correlation with inflation, most exhibit very little correlation with traditional stocks and bonds. Modern portfolio theory (MPT) stipulates that by adding asset classes with low or negative correlations to the existing assets, an investor can keep the same expected return for their portfolio while reducing its risk, as measured by the portfolio's standard deviation. A rational investor would choose to minimize risk while maximizing expected return, and the low correlation of commodities and traditional assets helps achieve this. (See also: Commodities, The Portfolio Hedge.)

The following table illustrates the historical correlations between the S&P 500 stock index and popular commodities indices for given periods. Picking up commodities at depressed prices can allow for a great bargain while increasing diversification.

Demographics: A Growing World Population Will Demand Resources

The global population is approaching 7.5 billion people, and those people will always need energy and food. Agricultural commodities such as wheat, corn and livestock might be a good investment at today's low prices. Energy production is increasingly turning to alternative, renewable energy sources such as wind and solar, but fossil fuels will remain a cheaper option for most of the world for the foreseeable future. The rate of population growth is not slowing down, and barring a global disaster, it will begin to put a strain on natural resources and food stocks alike.

One ETF that tracks world food prices is  E-TRACS UBS Bloomberg CMCI Food ETN (FUD), or alternatively there is the PowerShares DB Agriculture Fund (DBA). (See also: These Companies Are Poised for Growth as Global Population Growth Comes Online.)

The Bottom Line

Commodity prices have not been this low in over a decade. Everything from oil to metals to food commodities have fallen in price as the global economy has struggled to emerge from the Great Recession, demand from Asia has begun to falter. At the same time, supplies have increased with better and lower-cost production processes.

Still, this may be a unique buying opportunity for investors to snap up commodities at bargain prices, as they offer benefits beyond simple price appreciation. Storable commodities can serve as a good hedge against inflation, and commodities can also serve to diversify portfolios to reduce risk without sacrificing expected return. It's extremely difficult to time any market, but these prices are approaching lows they haven't seen in years. There are a number of publicly traded ETFs that allow everyday investors to gain exposure to both general commodities indices and to specific commodities.

 

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