(Seventh)
The third major asset class – ways to invest our money – is buying things that have the potential to appreciate. There is a huge variety. They can be works of art, collections, jewelry, precious metals such as gold, oil, grains, cryptocurrencies and other types of virtual assets, etc. Even real estate like land.
Unlike investing in a business, these types of assets do not produce income by themselves. They are simply things to which people give a value, which can go up and down depending on many factors. In some cases they are credited with inflation protection, or are thought to be “safe” like gold, even though their price is many times more volatile than stocks.
For simplicity, we will call this large class of assets commodities, which are defined as basic goods that can be exchanged for others of the same type. In general, they are used as raw material in production processes, such as oil, gold and other metals, grains such as corn, among others.
Of course, not all the goods mentioned above would fall into the definition of commodities, such as works of art or certain collector’s items, which are unique. However, when one acquires them as an investment, the aspiration is that they can be sold in the future at a higher price, and therefore obtain a profit. That is why I decided to include them in this “way” of investing.
Commodities, especially those that trade in financial markets, are generally the most volatile asset class there is and are subject to a great deal of speculation. One of the reasons is that they can be traded – exchanged – at the moment and physically (what is known as spot) but they are usually traded in the futures market. These are contracts that are known as “derivatives” and that obligate both parties to buy or sell a commodity at a certain price on a future date.
They are used as coverage, so that companies that use these commodities as raw material in their production processes can be certain of their costs. Because otherwise, they would be too exposed to the enormous volatility that the prices of these products have. The same, but in reverse, applies to producers. It is easy to imagine that any corn farmer would like to be certain of the price he will receive for his next crop.
Now, like any financial instrument, futures contracts are widely used for speculation. For example, today an ounce of gold is worth 1,885.20 dollars. Perhaps I think that the world is entering an inflationary spiral and that gold is going to rise a lot in the coming months, but I do not want to buy physical gold, since I have nowhere store it.
What I can do is buy futures contracts that guarantee me a price per ounce of $2,000 in January 2023. If spot gold is trading at $2,500 at that time, I will be making a profit of $500. If what I thought does not happen and the price of gold is lower than the futures contract, I will have to take a loss.
The above as an example. Let’s remember that this series is not about speculating, or chasing short-term returns, but about investing with a view to building wealth.
When you start to investigate, you find that for most of the years, commodities turn out to be the worst asset class and many investors do not incorporate them as part of their portfolio. In addition, as we already mentioned, they have a very high volatility (risk). A natural question would be, what would be its function in an investment portfolio? There are two potential reasons to consider including them:
They are generally considered hedges against inflation. When general prices are rising, commodity prices will tend to rise as well.
They provide diversification to an investment portfolio, because they sometimes move contrary to the prices of stocks or debt instruments. In other words, they can help reduce the volatility (risk) of an investment portfolio.
Finally, it should be remembered that not all assets that have the potential to appreciate are listed on financial markets, for example, works of art, or land. This is a very broad “way of investing” or asset class where we can find many subclasses with different properties and different risk-return ratio. Some may make more sense than others in our investment portfolio.
Personal Finance Coach
Heritage
Senior executive in insurance and reinsurance with strategic business vision, high leadership, negotiation and management skills.
He is also a Personal Finance columnist in El Economista, Personal Finance Coach and creator of the page www.planetusfinanzas.com