Effective means of hedging risk What is commodity investment?

The sluggish global economy and political instability have led to a growing interest in commodity investment. Commodity investment is still not well known in Japan and is generally regarded as a hurdle to overcome, but why is commodity investment attracting so much attention?



Hard and soft commodities

The global economy, which had been in the doldrums following the Corona pandemic and Russia's invasion of Ukraine, is gradually showing signs of recovery. Under these circumstances, commodity investment is beginning to attract attention.

Commodity investment literally means investment in commodities and refers to investment in ‘commodity markets’ such as crude oil, gold, copper and agricultural products.

Commodity investment is mainly categorised into ‘hard commodities’ and ‘soft commodities’. Hard commodities are precious metals such as gold, silver and platinum; industrial precious metals such as zinc and aluminium; minerals such as coal and uranium; and natural resources such as crude oil and natural gas.

Soft commodities include agricultural products such as wheat, corn, soybeans and coffee beans; livestock products such as breeding cattle and pigs; livestock feed; and raw materials for biofuels.

As these are real assets, they are also known as alternative (alternative) assets, as their price movements are different from those of financial instruments such as stocks and bonds, and they are suitable for diversified investments.

Advantages of commodity investment

The advantages of investing in commodities are that they are real assets that have value in themselves, so they are less susceptible to the effects of the stock market and easier to diversify, as financial instruments are.

For example, if a company's performance deteriorates or goes bankrupt, or a financial crisis shakes the entire stock market, such as the Lehman Shock, a portfolio consisting solely of equities is likely to be affected, but if the portfolio consists of a combination of real assets with low correlation to the stock market, the risk can be diversified.

Another advantage is that they are resistant to inflation. This is because, while prices rise and money values fall under inflation, physical assets such as precious metals and agricultural products increase in value in tandem with rising prices, making them more profitable.

Commodity investment has attracted attention in recent years because of the current global economic situation and the committed benefits of investing in commodities, and it is believed that investors who are actually investing in commodities are doing so for risk diversification purposes.

Some experts also point out that the current market outlook suggests that Europe and the US may fall into recession in 2024, and that commodity investment may be attracting attention as a risk hedge in the event of a deeper-than-expected economic downturn.

The reason for this is related to the price movements of stocks and bonds. As stocks and bonds were originally assets with different price movements, many investment trusts used bonds as a diversifying investment to hedge risk against stocks.

However, in recent years, the price movements of stocks and bonds have tended to move in sync, and bonds no longer function as a sufficient means of hedging risk, so the alternative is to invest in real assets with low correlation to the stock market, such as oil and gold, in other words, commodities.

Simplified diagram of commodity investment

Commodity investment can be categorised by time (short-, medium-, medium- and ultra-long-term), brand (metals, energy, agricultural products, etc.) and location (domestic and international), and investment forms include futures, cash and mutual funds. Commodities can also be categorised into hard and soft commodities.

Cautions on investing in commodities

Of course, there are disadvantages to commodity investment. Firstly, because commodity investments are real assets, unlike equity investments, there are no dividends or shareholder benefits, and no profit is generated even if the commodity is held continuously.

In addition, it is difficult to predict price fluctuations as different commodities have different price fluctuation factors. For example, agricultural products are susceptible to climate and natural disasters, livestock products to epidemics, and energy resources tend to fluctuate in price in response to political and global developments.

Commodities investment options Physical purchases and mutual funds

Despite these advantages and disadvantages of commodity investment, is it really easy for the average person to start investing in commodities (apart from experienced investors)?

The most popular methods of investing in commodities are physical purchase and mutual funds, but physical purchase is probably the most popular and realistic way for the general public to safely start investing in commodities.

Physical purchase

As the name suggests, physical purchase means buying physical commodities such as gold and platinum. Although physical possession makes theft prevention essential, there are no special procedures involved, as the desired commodity is simply purchased at a physical shop, such as a shop registered with the Japan Bullion Dealers Association, a jewellery shop, a bank or a department store.

In addition, consumption tax at the time of purchase and transfer tax at the time of sale are payable, but no tax is payable simply for holding.

Mutual funds

Mutual funds are a low hurdle for ordinary people to start investing in commodities because the fundamentals and timing can be left to professional fund managers, you can start with as little as a few thousand yen, and if you use a special account (with source), which does not require a final tax return, there is no need to calculate taxes.

There are also a number of publicly offered investment trusts that invest in commodities, and investing in commodity investment trusts can be started without the need to open a new account if you have an account at a bank or securities company.

More recently, there are also ETFs (exchange-traded funds).

ETFs are mutual funds that can be traded in real time like stocks and are designed to be linked to an index, so that buying one ETF issue has the same effect as buying the entire market it is linked to, and can be traded from a securities account in the same way as ordinary stocks.

ETFs listed in Japan alone allow investors to trade crude oil, natural gas, gold, silver, copper, platinum, nickel, wheat and soybeans.

If you have experience investing in equities in the past, you may want to consider investment trusts. However, in this case, it is important to choose the right mutual fund company.

Conclusion.

Despite these commodity investments, the global situation that was a concern even in 2023, such as Russia's prolonged invasion of Ukraine, the Israeli-Palestinian problem and China's economic slowdown, is expected to continue in 2024.

Also, looking at the global economy, as mentioned above, it is likely that commodity investment will attract even more attention in 2024 amid indications that the US and Europe may fall into recession in the year 2024.

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