Benefits of Investing in Financial Markets
Commodity markets are volatile yet profitable. A smart trader can take advantage of these prices swings to make good profits. If you keep yourself updated with upcoming fundamental events, you can position yourself in the market to your advantage. For example, war in a major oil-producing country like Iraq can cause oil prices to shoot up. Any major political or geo-political situation can send the gold prices higher. Well-planned commodity investments can provide higher returns than investments in other assets like stock, real estate and fixed deposits.
Trade With Lower Margins
An investor in commodity futures needs to deposit a certain amount as a margin with the broker. The margin can be close to 5–10% of the total value of the contract. This is much lower than the margin required for other asset classes and other investments like stocks, real estate etc. Thus, the investor can take larger positions while investing less capital. This also helps increase the potential for high profits.
Unlike investment in assets like real estate, investment in commodity futures offers high liquidity. It is easy to buy and sell commodity futures. An investor can liquidate his position whenever required. Secondly a quick withdrawal of your capital from the Exchange is an added benefit.
Commodities can diversify a portfolio. Commodity returns usually have low or negative correlations with the returns of other major asset classes. So often, when bonds and stocks fall, commodities rise. Factors that affect returns on stocks and bonds, for example, do not affect returns on commodities in the same manner. Besides, commodities may react differently from other assets in various economic and geopolitical situations. For example, the prices of stocks may fall during a financial crisis. But gold prices may rise as demand for this safe asset increases. A diversified portfolio with a low correlation between its assets tends to have less volatile returns. Thus, investing in commodities ensures diversification and improves risk-adjusted returns.
Inflation has a different impact on commodities than financial assets like stocks and bonds. This is because inflation causes currency to depreciate. This erodes the real value of financial assets like stocks and bonds. Commodities, however, maintain their value and price even during high inflation. In this environment, investors can turn to hard assets such as gold and other precious metals.
Hedge Against Risk Events
Events such as natural disasters, wars, and economic crises can lead to depreciation of an investor’s assets. This is an ‘event risk’. Such events affect financial assets like stocks and bonds negatively. They may also lead to a rise in the prices of certain commodities. For example, supply disruptions due to wars may raise the prices of commodities like oil. So, these commodities may act as a potential hedge against some event risks—a buffer against losses.