Critically assess the attractions of commodities as an asset class Essay

Critically assess the attractions of commodities as an asset class over the short and long-term - Essay Example The ever-expanding list now also includes products such as financial instruments and stock indexes that trade on a commodity exchange. Commodities can be considered to be an asset class in their own right and long-term investments in the same have resulted in equity-like returns to investors. An investment can generally be considered a separate asset class when its returns are independent of other asset classes; its returns are both positive and significantly different from cash; its return cannot be replicated with a combination of other asset classes. Commodities have all these characteristics and therefore provide considerable investment portfolio diversification opportunities. It provides return and risk opportunities beyond that of simple inflation hedging and has sources of risk and return that are significantly different from and independent of traditional assets such as stocks and bonds. Moreover, its advantage lies primarily in that its risk and return trade-offs cannot be easily replicated through other investment alternatives. Thus commodity investment has enormous growth potential and poses some unique attraction for investors who understand its unique characteristics, benefits and challenges. For instance, commodities generally outperform other asset classes in an expansionary phase and deliver extra-ordinary returns within short periods. Like property, commodities offer low to negative correlation with equities and bonds and fixed income instruments and, therefore, provide a natural balancing and sobering effect on the portfolio. A correlation coefficient is a number between -1 and 1 that measures the degree to which two variables are linearly related. A positive correlative coefficient means that the two variables are directly related, i.e. the value of one will increase or decrease along with the increase or decrease in the other. A negative correlation means that the variables are inversely related and when one