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Why would you add commodities to a portfolio? to make it better.
As the world's population increases, grows wealthier and urbanizes, we're consuming more raw commodities than ever before; from metals and energy to grains and livestock. However, the supply/demand story is not the number one reason to include commodities in a portfolio.
The bottom line is that commodities offer you diversification when you need it most. Major recent studies have found that portfolios can be enhanced by including commodities alongside other asset classes. Commodities can improve portfolio returns without increasing volatility*.
An independent asset class that behaves differently**: The real power of commodities lies in the fact that they are uncorrelated to the traditional mainstays of an investment portfolio: stocks and bonds. Commodity prices respond differently to economic conditions.
Natural protection from inflation risk**: Inflation is caused in part by increases in prices of essential goods, i.e. commodities. Directly investing in commodities provides a partial hedge against inflation risks.
A fundamental building block for every portfolio: Adding commodities as a third, individual asset class improves a portfolio's risk/return characteristics*.
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The most effective way to optimize exposure to real commodities (not commodity companies) is through a broad-based commodity index that invests in commodity futures - future price contracts for actual commodities.
See Criterion Diversified Commodities Currency Hedged Fund
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*Conclusion of Ibbotson Associates study, "Strategic Asset Allocation and Commodities", March 2006
**Both statements derived from AIG-FP and Ibbotson Associates data which looks at a 5-year rolling return information of stocks, bonds and inflation from 1959 to 2006
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