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Thursday, August 7, 2008

Commodity Investment Strategies

Capturing the full benefits of commodity exposure has been a challenge in the past.

Investing in physical commodities such as a barrel of oil, a herd of cattle or a bushel of wheat is of course, quite impractical, so investors have tended to look for commodity exposure either by purchasing commodity related equities or through actively managed futures accounts.

The onset of investment vehicles that track commodity futures indices has provided investors with another option for gaining exposure to commodities that may offer better potential to capture the full benefits of the asset class.

Investment vehicles that track commodity futures indices are not the same as actively managed futures accounts.

Instead, commodity index returns provide passive exposure to a broad range of commodities.

For example, the Dow Jones AIG Commodity Index tracks the futures price of 19 different commodities, including energy, livestock, grains, industrial metals, precious metals and soft commodities in the US.

Changes to the composition of the index are determined by preset rules rather than a manager's discretion.

One advantage of commodity exposure that tracks a broad index is that commodities are not highly correlated with each other and index returns should be less volatile than the returns on an individual commodity.

Another advantage is that commodity indexes themselves have existed for decades, providing ample historic data for asset allocation studies and research.

Commodities are a distinct asset class with returns that are for the most part independent of stock and bond returns.

Therefore, investing in commodities can help diversify a portfolio of stocks and bonds, lowering risk and possibly boosting returns. Reaching this level of diversification has been made easier with the development of investment products that passively track a broad range of commodities.

What qualities do you want your commodity broker to have?

1. Experience: Always make sure that your commodity broker has seen both bull and bear commodity markets. Also make sure that your commodity broker does not have a habit of being in trouble with the Exchanges.

2. Honest dialogue: Does your commodity broker call you when you are down in a trade as readily as when you are in a winner? Does your broker only call to ask you to send in more risk capital?

3. Availability during market hours: Is your commodity broker very often in a meeting or on the other line when you are trying to reach them during the trading day? Are your calls returned in a prompt and professional manner?

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