Commodities and Gold: Optimal Diversification or Unrewarding Risks? A retail perspective
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In this study we try to explore the concept of “Optimal Portfolio” in a holistic context. The main focus of the research is on “the commodity assets” that are and its relation with “the return the investor is getting from his or her portfolio”. The research also analyzes many aspects of “alternative Investments” and tries to gauge its effect on “the return that the investor will be receiving”.
Table of Contents
CHAPTER 1: INTRODUCTION6
Background of the Study12
Research Aims and Objectives14
CHAPTER 2: LITERATURE REVIEW16
Index Investment and Financialization of Commodities16
Investments in commodity derivatives18
Gold at the core of a portfolio20
Strategic Asset Allocation and the Role of Alternative Investments25
Principles Of International Portfolio Investment29
CHAPTER 3: DATA SET AND METHODOLOGY34
CHAPTER 4: RESULTS AND ANALYSIS38
SP-GSCI Index Return41
Investments in Gold46
Investment in Physical Gold46
Buying Gold Pool Accounts46
Investing in Gold Futures47
Buying Gold Backed Securities and Xetra - Gold49
Analysis of Gold as a Commodity50
CHAPTER 5: CONCLUSION AND RECOMMENDATION54
CHAPTER 1: INTRODUCTION
Investments in commodities have grown rapidly over the last years mainly via commodity futures and commodity index funds. It is estimated that “inflows into commodity investments during 2009 will be a record $60 billion, topping $51 billion from 2006” (Wall Street Journal, January 4, 2010) with the prospect being that they will increase further. Furthermore, Stoll and Whaley (2010) estimate the total commodity index investment in the US to be about $174 billion in 2009. The common perception is that the popularity of investing in commodities lies in the fact that, from a theoretical point of view, commodities form an alternative asset class; their returns are expected to show small or even negative correlation with the returns of assets that belong to traditional asset classes like stocks and bonds.
This is because the factors that drive commodity prices (e.g., weather and geopolitical conditions, supply constraints in the physical production, and event risk) are distinct from those that determine the value of stocks and bonds. Moreover, in contrast with stocks and bonds, commodities serve as an inflation hedge (e.g., Bodie, 1983).
In fact, a number of empirical studies confirm this type of correlation over certain periods of time. Consequently, diversification benefits, i.e. reduction of risk for any given level of expected return, may emerge. However, there is evidence that the growing presence of index funds in commodities markets integrates the commodity markets with the stock and bond markets. This calls into question the diversification benefits of commodities. This paper revisits the common perception on the diversification role of commodities by investigating the benefits of investing in commodities in a more general setting than ...