Allocating commodities to an investment portfolio can add many benefits to the portfolio including inflation protection and diversification. Commodities can include metals such as gold, silver and copper; natural resources such as crude oil and natural gas; agricultural products such as corn, sugar, wheat, soybeans, and coffee; and livestock such as cattle and hogs.
Commodities are typically purchased via futures contracts, which trade on a exchange. Market participants in the commodity futures markets include speculators and hedgers. Speculators buy and sell futures with the intention of profiting from their transactions, while hedgers purchase futures to protect their business from price fluctuations.
Adding commodities to an asset allocation can be beneficial in several ways. Such an allocation can provide protection against inflation by providing a hedge against a weakening currency. It can also reduce the risk in a portfolio by providing diversification away from more traditional assets such as stocks and bonds.
Futures contracts traded on U.S. exchanges are taxed according to the “60/40” rule. As per this rule, contracts are taxed at long term capital gains rates of 60% and short term capital gains rates of 40%. This rule applies regardless of how long the contracts are held, making futures contracts more attractive than stocks and bonds for short term trading.