by Rukhsana Zulfiqar

Created on: March 25, 2007

Investors, especially institutional investors are investing heavily in commodities. Commodities act as diversifier in investor's Portfolio. Nowadays, the trend towards investment in commodities is increasing. They provide negative correlation with equity and bond where as positive correlation with inflation. They give better returns in inflationary times when the performance of stocks and bonds is poor.

Commodities are bought and sold on the basis of speculation. Commodity futures or futures contracts are an agreement for buying or selling a commodity at a specific date in the future at a specific price. Prices of commodities changes on a weekly or daily basis. If the price increases, the buyer of the futures contract makes money, because he/she gets the product at the lower, agreed-upon price and can sell it at the higher market price. If the price decreases, the seller makes money, because he/she can buy the commodity at the lower market price. The seller can sell it to the buyer at the higher agreed-upon price. In the past few years institutional investment in commodities is increasing.

Commodities market comprises of the trading of forward contracts and futures contracts. Forward contracts are contractual agreements based upon buying and selling commodity between two entities. On the other hand, futures contracts are market agreements for buying and selling specific commodities between two entities over a recognized commodities swap.

Commodities futures are traded on an open market, so the price of each commodity can be accessed precisely. They have the ability to forecast the value of the commodity into the future. The values are set by traders and analysts of commodities, who daily research their particular commodity in which they deal. Commodities futures can be best invested and monitored through a commodities index or commodities fund. The most commonly traded commodities in market are oil and gold.

Commodities are a distinct asset class with returns which are largely independent of stock and bond returns. Hence adding broad commodity exposure can help diversify a portfolio of stocks and bonds, lowering risk and thereby increasing returns. Achieving this diversification can easily be accomplished with the development of investment products that passively track a broad range of commodities.

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