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Sep 20, 2022
Smart investors know the power of portfolio diversification. Diversification doesn’t entirely cut out the risk but helps an investor maximize his returns. A well-diversified portfolio includes several asset classes such as equities, bonds, mutual funds, currencies, and commodities.
Commodity trading has gained a lot of momentum in recent years. There are multiple ways of commodity trading for traders, both new and experienced. You can purchase quantities of physical raw goods, buy stocks of commodity trading companies, or go for commodity mutual funds or ETFs. Commodity trading exposes you to a wide range of products such as natural resources, agricultural goods, precious metals, energy, etc.
Here are a few more reasons why you must consider commodities.
Advantages of commodity trading
Potential Diversification Technique
Diversification is not a guarantee of profit but a powerful risk mitigation tool. Over a period, commodities tend to provide returns different from stocks and bonds. Commodities are considered for diversification because they have a negative or low correlation with stocks. A rise in commodity prices hikes production costs and lowers net earnings, impacting the stock prices.
Hedge against inflation
Inflation hits the price of stocks and bonds, but it often means higher prices for commodities. The present value of future cash flows of a business declines due to inflation, i.e., future cash can purchase lesser goods and services than it would currently.
A decline in stock price reflects this value erosion. In an inflationary environment, interest rates rise, which means higher borrowing costs and lower net income. In a nutshell, stocks do not perform well when the inflation rate is high, but commodities do.
Commodities are raw materials that are used in making the finished goods. Thus, due to high inflation, commodity prices rise. Hence, investors flock to commodity futures to maintain the value of their capital from the effects of inflation. Commodities perform well in periods of high inflation, but they could also be more volatile than other forms of investments.
Offers high leverage option
Commodity margins are lower for trading compared to stocks and bonds. The minimum margin for commodity trading may vary, though. As a result, it enables traders to earn profit by trading on borrowed funds. Commodity futures offer a strikingly high quantum of leverage. By paying an upfront margin of just 5% to 10% of the contract value, traders can take a substantial position. Even a minor move in the commodity prices can result in massive gains. Hence, using leverage in commodity trading can help you create an opportunity to earn huge returns.
Protection against volatile geopolitical events
Geopolitical events are entirely unpredictable. Situations like wars, riots, and political upheavals disrupt the supply chain, cause scarcity, and skyrockets commodity prices. Such happenings also lead to dismay in the stock markets as businesses and the economy are adversely impacted. The stock prices tend to decline, and investors turn to commodity trading to curb the losses in their portfolios.
Conclusion
Commodity trading is an attractive trading avenue that can help you build substantial wealth. However, like any trading tool, commodities have their quota of risks. Futures have unique inherent risks that must be managed irrespective of the underlying commodity. It can still be an effective way to diversify your portfolio if you understand the nuances of commodity investing.
Get started with hassle-free commodity trading with AXIS Direct. It is seamless, convenient, and offers you complete support as a beginner. You can trade on the go with our innovative RING app by linking your bank account. Brokerage starts at only Rs 10 per executed order. To get started, click here
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