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Commodities: Handy Hedges

By Joel Dresang

For the same reason you do maintenance on your snow blower before a blizzard threatens, it’s wise to include inflation protections such as commodities in your investments ahead of higher prices.

Commodities are raw materials such as grains, metals, oil and livestock, used for making consumer and industrial goods. Commodities represent limited resources that rise in value as demand grows or supply tightens.

The Great Recession has pushed inflation rates about as low as they can go. The core rate of the Consumer Price Index, the chief measure of inflation in the U.S., rose just 0.8% in 2010 – the lowest since records began in 1958.

That suggests it’s about time to make sure your balanced, diversified portfolio includes some defense against higher inflation, says Bob Landaas, president of Landaas & Company.

“More and more, it’s going to be important for investors to have positions in inflation hedges – just to make sure,” Bob says, “because at this point – because it’s barely measurable – inflation has nowhere to go but up.”

Besides commodities, other examples of inflation protections include Real Estate Investment Trusts and Treasury Inflation-Protected Securities.

As the global recovery gets into gear, demand will grow for commodities of all types, especially from the emerging markets, says Marc Amateis, vice president at Landaas.

Plus, Marc adds, as tangible assets, commodities become more attractive as investors shy from financial securities beleaguered by concerns over currency values or government debt issues.

“I continue to believe that for years to come there’s going to be enormous demand for commodities across the board – like food and industrial metals,” Marc says.

Another benefit of including commodities in your portfolio is that they can provide some protection against weakness in the U.S. dollar. About 85 percent of the world’s commodities are priced in U.S. dollars, so commodities exposure tends to be sort of an inverse dollar exposure. In other words, a declining dollar would likely cause commodity prices to go up, and a strong dollar will cause commodity prices to go down. As a result, commodity exposure provides a bit of a hedge against movement in the dollar.

Commodities can enhance investment portfolios because their prices are not strongly correlated to stock and bond prices and are negatively correlated to inflation.

Many investors already have some stake in commodities through international funds, which typically include other countries’ commodities in their holdings, Bob says.  Some invest in commodities directly, others through specialized mutual funds.

Joel Dresang is vice president of communications at Landaas & Company.

initially posted February 4, 2011

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