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Commodity Risks

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Commodities are used to diversify the source of your returns. Commodities react differently to market risks, often inverse to equity markets. They are often inversely affected by issues which hurt other investments like Inflation, Event Risk, and Geopolitical Risk. Commodity risks have a “negative correlation” to typical market reactions to risks.

Benefits from Inflation Risk

Inflation is a risk to almost every other asset class besides commodities. Increases in the money supply over time simply results in more money chasing the same amount of goods. Other issues causing currency value loss result in higher amounts of money to purchase the same amount of goods, which are developed from commodities. Commodity values increase nominally with inflation, instead of decreasing. Inflation risk is diversified by purchasing commodities.

Benefits from Event Risk

Negative events which harm or eliminate equity companies positively impact commodity values, at least temporarily. Wars, disasters, revolts, riots, or labor strikes harm regionally operating organization’s future cash flows. Equity value is based on cash flows and expectations. Event driven reductions result in decreased business values. The same events destabilize commodity supply chains. The interruption to the supply chain results in less resources available in relation to the same amount of money, increasing prices. Additionally, panic in equity markets results in investors seeking refuge in commodity markets. Investors commonly purchase gold during recessions and depressions, driving up the price and producing returns for investors with prior holdings. In short, commodities diversify event risk.

Benefits from Geopolitical Risk Benefits

As an extension of event effects on commodities, you may open yourself to geopolitical risk depending on how you decided to invest. If you’re invested in commodities via equities of a producer or supplier, commodity supply nationalization or access restrictions may destroy your share values. These risks harm firms, but concerns about commodity supply destabilization increases raw commodity values. This scenario may provide profit if you’ve invested long in futures, raw materials, or commodity index funds. This difference in results for commodities assets reveals an obvious truth. You must carefully pick your commodity investment method, since their risk exposure is not equal.

Risks

There are risks involved in commodities investments. Commodity markets are heavily populated by short term investors seizing profits from estimated rises and falls. In fact, unless you’re a commodities producer or supplier hedging your risks, you’re categorically one of them. They are known as speculators. They increase the market’s liquidity by adding their funds while increasing transactions resulting in lower volatility. They also bring their opinions, expectations, and emotions to the market. They may one commodity in large groups based on rumor or assumptions of price movement continuations. This drives up the price and profits investors who were already positioned in the space. They may short sell commodity investments they expect will be impacted by negative events, presuming a decrease in price. If their expectations prove wrong, they will unwind their positions. They can do this all together, significantly altering prices a second time.

Another risk is common to essentially all investments, fraud. Anyone can steal. Ensure that your brokerages are properly licensed. You need to fully research any future commission merchant, commodity trading advisor, or commodity pool operator. All of these parties must be fully licensed with the National Futures Association and should have a registered NFA ID number. You can also visit the NFA’s website to research their background:

If you see something on their background that concerns you, ask about it or take your business elsewhere. Ensuring that they are financially stable will reduce your chances of suffering from fraudulent activity.

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