Commodities are referred to as the fourth asset class. Unlike paper money, stocks, bonds and mutual funds, commodities such as oil, coffee, agricultural products, gold, silver, copper, platinum and palladium are tangible investments that have real life uses. Most financial advisors agree that commodities should be part of every investment portfolio, even if at a minimal percentage.
Investing in Cheap Oil for Rapid Gains
2014 saw a tremendous, unexpected decline in the price of oil. The price peaked around $110 and dropped over 50% over one year. As the world’s most important industrial and financial commodity, the change in price was a huge shock to the system. While there have already been important political and social ramifications of the price drop, the economic ramifications will be born out over several years.
As the impact of low prices hits oil producers, refiners, lenders and other investors, there will continue to be many opportunities for new investors to enter the market and take advantage of the low prices. Those investors that invested at $100 per gallon unfortunately were making their assumptions based on a flawed model. However, that creates an opportunity for investors now to reap the gains.
Fundamentally, oil still is a widely demanded commodity with over 90 million barrels used per day. While the supply has expanded in recent years, much of it costs more to produce than the current price of around $50. That means that the production will eventually be taken offline and the price will rise to a more reasonable level.
During this period of low prices and distressed assets, new investors have the advantage. Investors can make straightforward investments into oil futures betting on the price rise, or they can invest in big producers such as Exxon or Chevron which produce a steady cash flow, dividend and have substantial upside potential when the price rises.
Investing directly into oil futures provides the most potential for rapid upside, especially if the investment is leveraged. In fact, commodity futures generally provide much better leverage potential than stocks or bonds. Commodity investors receive up to 20x the money that they put into the market. Asset managers can help to decide which is the best structure for your investment based on your risk profile and tax situation.
Gold as a Hedge Against Monetary Inflation
Gold is one of the most widely traded and admired commodities. Investors have bought and utilized gold for centuries. In fact, it was an early form of currency itself. Gold officially backed all US money until the 1970s when the President Nixon took the US off the gold standard under the Bretton Woods Agreement.
Now that gold is free from its peg to the dollar, it is a way investors can hedge against long-term deflation. The amount of gold in the world only increases by a marginal amount each year. However, Janet Yellen at the Federal Reserve has the ability to expand our monetary base without limit. During the financial crisis in 2008 and 2009, Ben Bernanke increased the monetary base by several trillion dollars (depending on which assets are counted). At the same time, gold spiked from around $600 per ounce to $1,800 per ounce in three years as investors protected themselves against currency debasement.
Although gold has come off its peak from the early 2000s, the value is still holding well around $1200. Investors that fear another economic collapse or currency debasement invest heavily in gold. In fact, some of the largest investors in the world including hedge fund titan John Paulson are big investors in gold. Investors in rising economies such as India and China also have also proven to be fascinated with gold, which may be another factor in the rising price of this commodity.
Comparing Purchasing Power of the U.S. Dollar and Gold
Inflation has taken a toll on the US dollar over the last century. According to the CPI numbers released by the government, $1,200 in 1914 would have the same purchasing power as $28,408.32 in 2014. Yes you have read that correctly! Money printing and inflation are continuously devaluing the USD’s purchasing power. Gold, on the other hand, has a completely different story. In 1914, they said that one ounce of gold used to purchase a man a nice suit. Nothing has changed in 2014 or 2015 despite the plummeting gold price. An ounce of gold today can still buy you a really nice suit. In fact, you can probably buy two really nice suits for $1,200.