Sunday, February 26, 2006

Foolish commodities

Selena Maranjian, a contributor for the Motley Fool, takes a shot at explaining the attraction of commodities but, unfortunately, she just ends up looking foolish by taking the position that commodities are just too risky for most investors.
Investors are drawn to commodities because of the great leverage available. You can sometimes buy items by paying only about 10 percent of their value. In an extreme example, if you buy $50,000 of pork bellies for $5,000 and they double in value, you've made a lot of money by investing just a little. Of course, if pork bellies fall in value, you can lose your entire invested amount -- and then some! You can lose much more than you invest with commodities and futures. Smart people have lost a lot of moola this way.
Leverage is an important feature of commodities investing, but not the primary attraction. The cool thing about frozen orange juice and pork bellies is that they have little or no correlation to the other asset classes that you own like stocks, bonds, cash and real estate. The central tenet of asset allocation is that, if you combine a bunch of risky assets that have low correlations to one another, then you have actually reduced risk. That's not so foolish now, is it?

Commodities have been long been available to average investors through managed futures which are kind of like mutual funds of futures contracts. But it just got easier to get exposure to commodities with the recent launch of a new ETF, the Deutsche Bank Commodity Index Tracking Fund (DBC). Check it out but remember, this is just the first commodities-based ETF, there will be others soon.

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