Chapter 7Owning Commodities in a Balanced Portfolio

Assets that hedge against the risks of rising inflation are hard to come by. The traditional asset classes of stocks and bonds are both biased to outperform during periods of falling inflation. Consequently, traditional portfolios—which are mostly invested in stocks and bonds—are highly exposed to environments in which inflation is rising. These types of portfolios tend to perform extremely poorly during climates dominated by rising inflation, as should be expected given the predictable return patterns of these asset classes in terms of their economic bias.

In the last chapter I discussed how the inflation protection TIPS offer is a benefit to portfolios. TIPS provide direct inflation protection because returns to TIPS holders are inflation-adjusted. Commodities represent another asset class for your portfolio that covers the rising-inflation environment category. In this chapter I will first explain how commodities investments work, since the investment structure is different from the asset classes previously discussed. Next, commodities will be viewed through the conventional lens and the flaws in this thinking will be exposed. Finally, I will walk you through how to analyze commodities through a balanced portfolio perspective to help you appreciate how this asset class fits within a total balanced portfolio framework.

What Are Commodities Investments?

There are various commodities in which you can invest. A short list of ...

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