It’s the dawn of a new year and investors are facing an array of fresh challenges. One of the intriguing investment parlor games is to contemplate whether stocks or commodities loom as the vehicles offering the best returns.

Stocks enjoyed a spectacular showing in 2013. But investors may fret that it is unrealistic to expect continued glowing returns from the Standard & Poor’s 500 in 2014 and thus turn to commodities.

Market psychology will undoubtedly play a part in day-to-day price action as many investors naturally feel comfortable taking profits and not pressing their luck. Smart investors tend to manage “against the wind,” as Sandy Weill, the famed Wall Street titan of yesteryear used to like to say. In 2013, commodities fell about 9%, according to the Dow Jones-UBS Commodity Index. The iPath Dow Jones-UBS Commodity Index Total Return Exchange-Traded Note (NYSE:DJP)  has shed roughly 10%. Meanwhile, the S&P 500 Index, climbed some 25%, putting it in line for its best year since 2003.

Some grizzled financial-markets veterans are wary of the prospect of seeing individual investors, skittish of stocks because of their stellar 2013 performance, now turn to commodities.

“If you’re an individual and you want to invest in commodities at all,” says Michael Holland of Holland & Co. in New York, “you’re probably safer by taking a look at companies that are involved in the commodities business. I’m not a fan of seeing small investors messing around with commodities, though. I think it’s a loser’s game because these investors aren’t knowledgeable enough to anticipate the volatility and changes in the markets. I’ve often seen individuals get in over their heads by investing in commodities – and they wind up losing a lot of money. I’d stick with stocks over commodities. I have a hard time not liking stocks.”

Commodities mavens would be wise to follow such factors as supply, demand and currency exchanges, but Anton Bayer of Up Capital Management in Granite Bay, Calif., says central bank monetary policy belongs “at the top of the equation.”

“While monetary policy remains accommodative in both U.S. and world central banks, commodity prices in general will remain under pressure,” Bayer said. “When – not if – central bank policies change is when all market classes will experience a jolt in volatility as world economies adjust to losing the benefits of low-cost bank funding.”

To many individual investors, the lure of commodities can be summed up in one vehicle: gold. Gold gets the most general discussion and it is widely regarded as a hedge against stocks. When something catastrophic, such as a terrorist attack somewhere around the globe, happens, you’ll likely to hear investors touting gold.

But gold took a beating in 2013. As of the close on December 19, gold prices as measured by the SPDR Gold Truest ETF (NYSE:GLD) lost 29% year to date in 2013. That would clock in as the biggest annual loss for gold futures since at least 1984.

Some professional investors sidestep commodities futures in favor of more tangible investments.

“I do not ever put my clients into commodities – ever -- except for gold and silver, ‘GLD’ and ‘iShares Silver (NYSE:SLV),’ " said Thomas Cloud, of Eleven Two Fund Management in Marietta, Ga. "If you want to go into commodities, I would recommend those two because each one actually tracks the spot prices of these commodities. Mutual funds are tracking the futures of cotton, cocoa, oil and energy. It means you're investing in ... air.”

So, if stocks remain a professional’s investment of choice, what figures to be the best selection? Small-cap stocks, defined as stocks of companies with between $1 billion and $2 billion in market capitalization, outperformed large-cap stocks last year, Cloud said.

“We've seen U.S. stocks outperform foreign stocks in 2013,” Cloud said, “and 2014 seems as good a year as any for that to come to an end. International stocks are picking up steam.”

The Bottom Line

No one can say for sure where the financial markets are going in 2014. When it comes to investing, perhaps the most crucial factor is your comfort level when it comes to risk. Many investment experts suggest that commodities represent a bigger inherent risk than the equity markets by the very nature of the volatility of these vehicles. But if you're comfortable rolling the dice somewhat, then you might want to take a closer look at commodities for your portfolio.


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