Tips
Are You Making These Common Mistakes When Investing in Commodities?
Imagine the scenario, you saw the gold market Australia tumble and tumble through the news cycle, heard rumors about copper, and noticed the rise in prices of aluminium in the stock exchange. Nonetheless, even with all the hype, the average Australian investor continues to think of commodities as some sort of enigmatic, high-risk, side-project, but not a core of a balanced portfolio. The result? Missing chances, the needless loss and a general feeling that I might not be doing this right.
And that is how you have ever felt. Commodities – not only precious metals and energy, but even agricultural products provide an excellent form of diversification, inflation hedge and may even increase long-run returns. However, there are some pitfalls on the way to success that should be taken into consideration. We will take you through these errors in this post, equip you with valuable experience and guide you to avoid the most common commodity investment traps.
1. Shaking Commodities Like a Lottery Ticket
The greatest error that most Australians commit is making commodity purchases a gambling game. It is simple to get caught up in the headlines of a sudden price surge or a political phenomenon that has happened and one way or the other pushed the price of oil to an all time high. Investors may fall into the trap of making hasty purchases without any plan.
The fact of the matter is that commodity prices are unstable to say the least. In this case, gold can increase this year and decrease the next, and crude oil can collapse in a supply crash. When you purchase commodity futures, you are not actually purchasing the product but you are wagering on the movement of the market. Without a systematic process, luck is on the wrong side.
What to do instead? Commodity exposure needs to be treated as a long-run, systematic component of your portfolio. Think about setting aside a small portion (5-10 percent) of your wealth in commodities and allow that portion to be determined by your general level of risk and your long-term investment horizon, and not the noise of the short-term market.
2. Neglecting Role of Costs and Fees.
The second, less evident error is an oversight of the cost structure which encircles commodity investing. Regardless of whether you are purchasing literal gold, investing in an ETF tracking a commodity index, or trading commodity futures, you will lose much of the returns over time due to fees.
ETF expense ratios, bid/ask spreads and brokerage commissions are cumulative. In the case of futures, you will also have to deal with margin requirements, settlement costs on a daily basis and roll-over fees, which could be incurred in case you are holding a position over the expirations of the contract. And in the case of physical commodities, storage and insurance might introduce invisible expenses.
The remedy: Shop cheap ETFs, think about owning a physical commodity directly in case you have the space and experience, and ask your broker to tell you about some hidden costs. Also remember to allow for the tax effects – in Australia, it is possible to tax commodity trading in a different way than capital gains on shares.
3. Failure to hedge Inflation or Diversify adequate.
Most Australians are confusing commodities as an automatic inflation hedge and that is not all. Although gold and other precious metals tend to increase in case there is fear of inflation, other commodities do not behave in the same manner. The increase in inflation might actually reduce energy and agriculture due to tightening of the monetary policy and increased cost of borrowing.
The risk: Trading commodities as a sole measure against inflation could expose you to the risk in case the commodity price is going in the other direction.
The answer: Have a blend of types of commodities and combine with other defensive investments such as good dividend stocks, bonds or real estate investment trusts (REITs). Consider the commodities as a component of a balanced portfolio, but not the meal.
4. Ignoring the Effect of Geopolitical and Environmental Conditions.
Geopolitics and the environment are living and breathing commodities. Unavailability of supplies due to sanctions, trade wars, or natural disasters can have a volcanic effect on prices. An unexpected drought in Brazil can add to the constraints on coffee stock; a new backlog in Indonesian mining can impact the price of nickel.
What most people overlook: When people invest in a commodity, they do not know the dynamics of supply behind it hence they are at the mercy of unpredictable events.
The way to prevent it: Do your homework. Track the news of reliable sources, check news reports within the industry and monitor the politics in the major producing areas. In case you are investing in a commodity which is very dependent on a particular country, then you should look at diversifying the sector or incorporating a related commodity with more stable supply chains.
5. Not Hiring a Personal Financial Planner.
The Australian financial environment may be tricky when references are made to commodities. One of the pitfalls is to do it alone without the guidance of professionals. There is such a delicate aspect of commodity investing as the knowledge of tax regulations, risk management, and interaction of various asset classes.
The importance of a planner: A competent personal financial planner can assist you in considering how commodities can be included in your overall financial planning. They will evaluate your objectives, tolerance of risks and time and advise you on how best to allocate to the commodities as compared to other assets. They can also assist you in getting through the taxation of commodity trading so that you are not leaving money on the table.
Action step: In case you really want to take commodities in your portfolio, you can make an appointment with a personal financial planner. They will offer an effective, individualized roadmap that will consider your personal situation.
6. Purchasing Physical Commodities without a storage facility.
Precious metals such as gold are physical resources which are not owned in a physical sense as it seems. You require a safe deposit box or a home safe or a good vault service. Both options have a price, storage fees, insurance fees, and in some cases a minimum balance requirement.
Best practice: Research a reputable vault provider with insurance and open fee policies. A high-security home safe may last long enough in the event of loss, though this may be required in case of a loss since you are buying a smaller home safe.
7. Poor interpretation of the Signals of the Gold Market Australia.
The Australian gold market is an important phenomenon in the world arena, and its indicators are misguiding in case of direct interpretation. The abrupt increase in domestic gold mining supply, say, could cause the decrease in prices on the world arena, still, it does not necessarily imply that the market will remain cheap in the long-term perspective of the investors.
The most frequent causes of failure: Investors attach themselves to the price fluctuations in gold market Australia in the short term and make their buying or selling decisions impulsively without having a look at what is happening around the world.
A considerate strategy: Consider more than the domestic market. Compare Australian supply data with international production, compare the demand in key markets (China, India) and look at macroeconomic indicators like inflation expectations and central bank policy. This is the wider view which will give you a better picture of how gold may really be undervalued or overvalued at any particular time.
8. Losing Track of Re-balancing Your Commodity Exposure.
Commodity exposure, like any other asset class, can over time move out of your intended allocation. When the price of gold spikes up 10% commodity allocation can explode into 15 percent or more of your needs. This will (otherwise) distort your risk profile.
The risk: The over exposure to commodities can increase volatility, particularly when you are approaching retirement or have a low risk tolerance.
The solution: As often as you can (usually quarterly) check, and re-adjust your portfolio to its planned form. It can include selling a part of the high-performing commodities and purchasing additional of the under-represented ones. Discipline will ensure that your portfolio is in line with your goals.
9. Not taking the Importance of Liquidity.
Liquidity of some commodities may be limited, especially of some niche metals or rare agricultural commodities. This implies that you may not be able to sell when you must or you may be forced to lose your money in order to get out.
What to do: Give priority to liquid, widely traded commodities, such as gold, silver, platinum or generic energy futures. In case you wish to invest in assets that are less liquid, invest using an ETF or managed funds that provide an element of liquidity and professional management.
10. The Underestimation of the Impact of Timing and Market Sentiment.
Lastly, a large number of Australians get into the trap of believing that they can time commodity markets. They are either waiting to get the ideal point to enter and they miss the climb, or they sell when it is in a downturn only to enter again at a new high price. Commodity markets are affected by sentiment, speculations and macro-economic forces, which are hard to predict.
You should not pursue timing but have a regular investment program. Dollar-cost average to even out your buying over time, and this averages out fluctuations in prices over time. This approach discourages the urge to time the market and is more consistent with long-run returns.
