CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

26.2 DIRECT PHYSICAL OWNERSHIP OF COMMODITIES

Most investors avoid holding physical commodities, because storage can be cumbersome and expensive. For example, barrels of oil require a storage tank as well as transportation from the purchase site. In fact, some commodities are perishable (e.g., many agricultural and livestock commodities), making them virtually impossible to store for an extended period. Precious metals are an exception. Investors often hold precious metals in the form of bullion or coinage. Gold is especially easy to store, and gold investors have historically preferred to hold physical gold rather than gold derivatives.1 In short, real assets such as commodities require a degree of active management in order to maintain their value. Furthermore, research suggests that, over the long term, the prices of physical commodities have not kept up with inflation, which is in stark contrast to the returns generated by other forms of commodity investment, such as commodity indices (Gorton and Rouwenhorst 2006). As a result, most commodity investments are made through derivatives contracts, such as futures contracts, forward contracts, swaps, and options. This allows the owner to benefit from price changes in the commodity without the need to store it.