What commodities such as oil and gold can offer investors

Investing in commodities? The first reaction of many investors right now would be no: they’re too opaque, too risky. But as is so often the case with financial investments, it is worth taking a second look at a step back to get the bigger picture. Investing a small portion of a long-term investment in commodities can be a sensible move that actually reduces, not increases, the risks of your portfolio. This has been borne out by long-term analyses conducted by the DWS Research Institute.^[1]

Generally speaking, investors have neglected the strategy of broad diversification in recent years, according to the capital market experts at DWS. But in a decidedly difficult capital market environment - which DWS researchers expect to persist for the next ten years at least - the appropriate allocation of assets to different asset classes is likely to play a significant role. Investment strategists expect commodities will provide a staple ingredient in the right portfolio mix. 

Think long-term and mix asset classes

In order to further spread their risk and increase their chances of a satisfactory return, investors should not only be putting their capital into bonds and equities but also into additional asset classes. According to a recent study by the DWS Research Institute,^[1] so-called ‘asset allocation’ (the allocation of the portfolio to different asset classes) determines 90 percent of its performance.

Commodities counterbalance traditional asset classes

Supposedly risky commodities such as oil and gold can then be a canny addition to the portfolio; their key advantage being that their performance differs significantly from that of bonds and equities and in some cases even runs counter to it (negative correlation). The development of the gold price over the past 30 years, for example, correlated only slightly more than five percent with the development of the global share index MSCI World – i.e. the correlation was hardly discernible. The price of crude oil correlated by only 15 percent by comparison. While the correlation with the bond benchmark index Bloomberg Barclays Global Aggregate has remained very low since 1990.

In Europe, the contrast is more perceivable: if one compares the gold price with the European stock index Euro Stoxx 50 since 2004, a clear negative correlation is evident: whenever gold was up, Euro Stoxx was in a downward trend. Historically, commodities have proved to be a suitable instrument for portfolio diversification.

Gold to Crude Oil

Correlation of EuroStoxx 50 with gold and crude oil

What can investors expect from commodities in the future?

The DWS Research Institute forecasts an annual return of more than three percent over the next ten years for investments in commodities, while it anticipates US equities to generate a significantly higher return of around six percent per year in the coming decade. However, a higher return expectation is always linked to a higher risk. A carefully positioned and balanced portfolio should also include other promising investments, not just equities.

Broadly diversify with mixed funds and leverage commodities

For investors wishing to broadly diversify, mixed funds are a straight forward and easily manageable option. In principle, they can be invested in all asset classes and they often include a share of commodities in their portfolio.