What are Commodity Funds?

Commodity funds are funds that invest in commodities, such as gold, energy, cattle, or wheat. Although commodity funds can be financially rewarding, they are also often volatile and complex. As a result, novice investors can find these funds challenging to navigate. Before including commodity funds in their investment portfolios, savvy investors should take care to educate themselves about how these funds operate in order to ensure they end up with the best possible investments.

A variety of commodity funds exist in the marketplace. Some of these funds actually own the physical asset that they represent. For example, a silver fund falling in this category would own silver bullion and issue units against it.

A more widespread strategy for commodities investing is trading them as futures contracts. Under this method, the parties contract to buy or sell a fixed amount of a commodity for a fixed price at a future delivery date. Commodity futures contracts are frequently traded on a futures exchange. Some commodity funds are combination funds, and have holdings that include both physical commodities and futures contracts.

Another type of commodity fund is a natural resource fund. A natural resource fund generally doesn’t hold the actual commodities or futures contracts. Instead, it typically invests in companies that operate in commodity-related fields. For example, a natural resource fund may invest in a wind farm or an oil company.

Speculating in the commodities market can prove advantageous for investors. The rules of supply and demand govern the commodities market. When demand is high, prices typically increase, allowing commodity funds to realize increased earnings. A commodity fund can also offer protection from the impact of inflation because commodity prices generally increase when inflation rises.

Investing in commodities can provide individuals with the ability to add diversification to their investment portfolios. Fluctuation in the commodities market does not always mirror traditional equity markets, such as the stock market. This low correlation is a key consideration for individuals seeking to vary their investments.

There can be disadvantages to investing in commodity funds, however. The commodities market is often unstable, and price swings can fluctuate from extreme highs to extreme lows within just a few days. Fees paid to these types of funds can also be high. Funds generally charge ongoing management fees and take a share of the profits. On top of these fees, investors may also pay fees to brokers who collect trading commissions.

Prior to investing with a particular commodity fund, potential investors should take care to learn about the fund’s holdings and to review the fund’s prospectus and annual report. Investors should also understand what they are purchasing and how that will impact the rest of their investment portfolios. Given the risks often associated with the commodities market, investors may also wish to limit their holdings to a small percentage of their overall investment portfolios.