Why should I invest in precious metals and other commodities?

You may have noticed headlines about gold reaching record highs, platinum prices rising or oil becoming more expensive. You may also hear investment professionals talking about “resources” or “commodities” and wonder what this means for you as an investor. 

So, should you invest in commodities such as gold, platinum or oil? And if so, how? 

The answer depends on what you are trying to achieve with your investment, your tolerance for risk and how commodities fit into your overall portfolio. 

What are commodities?

Resources or commodities are raw materials and natural resources that are traded globally. They include precious metals such as gold, silver, platinum, palladium and rhodium; industrial metals such as copper, iron ore and manganese; and energy products such as oil and coal.

There are also “soft commodities”, which include agricultural products such as wheat, maize and coffee.

Commodities are different from shares. When you buy a share, you are buying part of a company. When you invest directly in a commodity, you are gaining exposure to the price of the underlying raw material.

You can also invest in companies that produce commodities, such as mining companies. In this case, the company's share price is influenced not only by the commodity price, but also by factors such as its production, costs, debt and management. 

Why do commodity prices move? 

Commodity prices are largely driven by supply and demand. 

For example, if demand for copper increases as economies invest in infrastructure and electrical equipment, but copper production cannot increase quickly enough to meet that demand, the price may rise. 

The opposite can happen when economic growth slows and demand falls. 

Supply can also be affected by events such as extreme weather, strikes, mine disruptions, geopolitical tensions or changes in government policy. This can cause commodity prices to move sharply, sometimes over a short period. 

Currency movements also matter. Many commodities are priced internationally in US dollars. For a South African investor, changes in the rand-dollar exchange rate can therefore affect the rand value of a commodity or a commodity-related investment. 

This is one reason resources shares and commodity investments can be more volatile than many other investments. 

Why do investors consider investing in commodities?

Commodities can play a role in a diversified investment portfolio because their performance can be driven by different factors from those affecting traditional assets such as shares and bonds. 

Gold, for example, is often viewed as a potential store of value and can behave differently from riskier assets during periods of market uncertainty. Other commodities, such as industrial metals, tend to be more closely linked to economic activity and demand. 

Resources companies can also provide exposure to rising commodity prices. If the price of a commodity rises while a mining company's costs remain relatively stable, its profitability can increase. However, the opposite is also true: falling commodity prices can put pressure on profits. 

Commodities can therefore provide diversification, but they should not be viewed as a guaranteed source of returns or protection against inflation. 

How can I invest in commodities? 

There are several ways to gain exposure to commodities. 

• Invest directly in a commodity - Some investment products provide direct exposure to commodities such as gold or platinum. 

• Invest in commodity-related companies - You can buy shares in companies that mine or produce commodities. This gives you exposure to the underlying commodity, but also to the performance of the individual company. 

• Invest through an exchange-traded fund (ETF) or exchange-traded note (ETN) - These products can provide exposure to a particular commodity, a group of commodities or companies operating in the resources sector. 

• Invest through a diversified fund - Many unit trusts and retirement funds invest in resources companies as part of a broader portfolio. Multi-asset funds, for example, may have exposure to resources alongside shares, bonds and other asset classes. 

For many investors, this last approach provides exposure to the resources sector without having to make a large investment in a single commodity or mining company. 

How much should I invest? 

There is no “one-size-fits-all” allocation that is suitable for every investor. 

Your investment should reflect your financial goals, investment timeframe and tolerance for losses, as well as what you already own. 

A conservative investor may have relatively little direct exposure to commodities and instead gain some exposure through a diversified portfolio. 

An investor with a higher tolerance for risk may choose to have more exposure to resources shares or commodities, particularly if there is a strong investment case for a particular commodity or sector. 

The important point is that commodities should generally be considered as one part of a diversified portfolio rather than as an investment strategy on their own. 

What are the risks? 

Commodities can offer diversification and potential growth, but they also carry significant risks that investors need to consider. 

• Prices can be volatile. Commodity prices can move sharply in response to changes in supply, demand, economic growth, interest rates, currencies or geopolitical events. 

• The commodity cycle can work against you. A commodity that has performed strongly can fall just as quickly if supply increases or demand weakens. 

• Mining shares have additional risks. A mining company can be affected by rising costs, operational problems, labour issues, regulation and management decisions, regardless of what happens to the commodity price. 

• Direct commodities do not pay dividends. If you invest directly in a commodity such as gold, your return depends primarily on changes in its price. Unlike shares, the commodity itself does not generate an income stream such as a dividend. 

• Concentration can increase risk. A portfolio heavily concentrated in one commodity or sector can be more vulnerable to a downturn. Diversification remains important. 

What about ESG considerations? 

Investing in resources also raises environmental, social and governance (ESG) considerations. 

Mining and other resource activities can have an impact on land, water, biodiversity and surrounding communities. Companies may also face challenges relating to worker safety, labour practices and relationships with local communities. 

ESG has not reduced the world's dependence on commodities; it has changed the types of commodities that investors favour.  

The move towards cleaner energy is creating strong demand for minerals needed in batteries, electricity networks and renewable power generation, while some high-carbon commodities face greater pressure from regulation and changing investor preferences.  

But with the geopolitical tensions creating dislocations in the energy sector there has been a shift towards energy security and fossil fuels will need to be around for longer as governments replenish strategic stockpiles and diversify their energy mix 

Many of the materials needed for the transition to a lower-carbon economy – including copper, platinum group metals and other minerals – need to be mined. 

Investors need to consider how individual companies manage their environmental, social and governance factors, as well as the role their products play in the changing economy and in shaping the future. They are increasingly looking beyond the commodity itself and considering whether it is extracted and/or produced in a responsible and sustainable manner. 

What do commodities add to a portfolio? 

Commodities can have a useful role in a diversified portfolio, but they are not suitable for every investor, and they should not be viewed as a shortcut to high returns. 

The key is to understand what you are investing in and why. 

Before investing, consider whether you are looking for diversification, exposure to a particular commodity, potential protection against certain economic risks, or long-term growth through resources companies. 

For most investors, the starting point should be a well-diversified portfolio aligned with their goals and risk tolerance. Commodities can then be considered as one component of that broader strategy. As always, we recommend that investors consult their financial adviser to map out an investment strategy that is carefully aligned to their individual circumstances, and overall portfolio. 

This article was written jointly by Laura du Preez and Aeysha Samsodien, co-portfolio manager of the M&G resources funds