Portfolio Diversification and Commodities

Diversification with commodities is getting easier, the SF Chronicle has the details:

However, new avenues for commodities investing are emerging in the form of exchange-traded funds.

Exchange-traded funds, as you may know, trade just like regular stocks and are becoming increasingly popular as a substitute for index mutual funds. While conventional mutual funds discourage frequent trading, you can buy and sell the same ETF all day long, should you desire. Thus, ETFs are useful for traders who want to quickly move into and out of particular industries or other market segments.

Recently, a new form of ETF has emerged. It started in November 2004 when the StreetTRACKS Gold Shares fund (ticker symbol GLD), which tracks the day-to-day movements of gold bullion, started trading. Just two months later, in January 2005, the iShares Comex Gold Trust (IAU), which also tracks gold bullion, became available.

The next shoe dropped on Feb. 6, when the Deutsche Bank Commodity Index Tracking Fund (DBC) began trading. Unlike the gold funds, which track a single commodity, the Deutsche Bank fund attempts to mirror an index that tracks the prices of the major commodities: crude oil, heating oil, gold, aluminum, corn and wheat.

Recently, the first exchange-traded fund that tracks oil prices became available. The U.S. Oil Fund (USO) tracks the movement of West Texas intermediate crude oil futures, which is the U.S. oil price benchmark. Another ETF that tracks the price of silver will probably be introduced shortly.

If you're in the camp that thinks gold, oil or commodity prices in general are headed higher, you can buy the appropriate ETFs. Conversely, if you think that gold prices have peaked and are headed down, you can sell one of the gold ETFs short (short selling is a strategy for profiting when a stock or fund price drops).

Commodity prices often move opposite to the overall stock market. Thus, some experts advise allocating a small percentage of your portfolio to commodities to hedge against an inflation-driven market downdraft.