Avoiding Whiplash From Commodities

|
Includes: DBC, SLV
by: Intelligent Speculator

The past few weeks have seen incredible action in commodity prices. Oil and gold have suffered greatly, but nothing was even close to the collapse in silver prices. It’s a challenge to draw any conclusions from such dramatic movements. For months, these metals had been gaining steam because of both retail and institutional buying. Then last week, news came out that some of them had started closing their long positions on silver.

It’s not clear if they knew something or if their selling created even more selling, but that pretty much marked the start of a spectacular decline. Just take a look at the charts and you will get an idea.

Part of the cause was also the exchanges themselves. Seeing what they considered “excessive” speculation, the CME raised its margin requirements on silver contracts, making life more difficult and more expensive for silver traders.

[Click all to enlarge]

Investing In Commodities

Seeing commodities become so volatile certainly raises some questions. Should you have commodities or commodity exposure in your passive income retirement portfolio? I would personally say that yes, you do. Commodities are already an important portion of the world economy and with Chinese and other emerging markets demand, that is bound to continue its increase. Thus, in the long term, it certainly seems like a no-brainer to own them.

Commodities are also uncorrelated to most of the markets, so they have a valuable contribution to your portfolio in terms of risk/reward. That being said, I think events like what happened last week give a good example of why you do not want to have commodities as the main part of your portfolio.

I do believe that over the long term commodities will increase significantly. However, fundamentals are kind of lost in a sea of traders when it comes to commodities, making life much more stressful and difficult for those with a long-term view.

Should Speculators Trade Commodities?

It’s a fair question, isn’t it? Since commodities started trading because farmers wanted to hedge their crops, times have changed quite a bit. Now actual buyer and sellers are involved in high-stakes poker games where it becomes very difficult to predict what is taking prices up and down.

There are also more serious issues. Honestly, how could you possibly try to determine who is “hedging” and who isn’t? Millions of companies have some kind of exposure to silver, making it virtually impossible to determine what is hedging from what isn’t. For gold, that would be unthinkable, as many use gold as an inflation hedge. There’s just no way it could work.

When It Extends to Food

Paying more for energy or metals is unfortunate for most, but for speculators trading commodities, it truly starts to get attention when it affects food prices. Billions of people around the world depend to some extent on food prices, and having these prices fluctuating by 10-20% or even more can make life very unpredictable for the billions that do not have enough to tolerate such movements.

How To Get Some Commodity Exposure?

There are many different ways, but by far the cheapest and most efficient solution involves ETFs. We have discussed the top ones many times but I think you want to focus on two types of ETFs: Commodity ETFs that hold physical commodites (such as GLD) and futures-based ETFS that do not roll monthly but rather infrequently. They will suffer less erosion.