Should You Trade Commodities or Commodity Stocks?
by John Jagerson 02/02/09
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This article originally appeared on the Learning Markets Web site.
You may be wondering what is the best way for a trader to gain exposure to commodities. Does it make more sense to buy commodities and commodity ETFs, or are commodity sector stocks and ETFs a better choice?
The correct answer is probably a matter of understanding the differences between the two types of commodity investments and how it relates to your total portfolio.
Commodity sector ETFs spread the investment among several stocks in the same sector. For example, the Market Vectors Agribusiness ETF (MOO) invests in a blend of stocks involved in the production of agricultural products.
These stocks include Monsanto (MON), Archer Daniels Midland (ADM) and Deere and Company (DE). The fund is diversified among different stocks but the fund as a whole is still highly correlated to the major stock indexes.
Commodity ETFs invest in either the actual commodity they represent such as the SPDR Gold Trust (GLD) or in commodity futures. The price of these ETFs will only be affected by the price of the underlying commodity itself. Commodity ETFs typically have a much lower correlation with the major stock indexes.
How correlated an asset is to the stock market is often measured by its "beta." A stock or ETF with a beta close to or more than 1.0, such as a commodity sector ETF does not provide as many diversification benefits for an investor already heavily invested in stocks.
Therefore, if an investor wants exposure to commodities but already has large investment in equities then commodity ETFs with betas of less than one are a better choice as they will be more uncorrelated.
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