Commodities' role in portfolios

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THE LONG AND SHORT OF INVESTING: Arabica beans on a Brazilian farm. A severe drought in Brazil has damaged crops and sent prices soaring this year.
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With Brazil's north-east facing its worst drought in 50 years, coffee prices soared almost 90 per cent in the first three months of the year, as rough weather damaged the crops of the world's biggest java producer.

Over in Europe, fears of a cut in the supply of natural gas, brought on by the political turmoil in Ukraine, sent prices surging last month.

While these two recent examples highlight the volatility of commodities, they also show how their prices are affected by demand- supply fundamentals, including geopolitics, weather and environmental risks.

Commodities, with their different risk factors compared to stocks and bonds, can thus be a good way to diversify an investor's portfolio, said Mr Simon Teo, strategist and private-client service manager at Phillip Futures.

"Over the long term, commodities, as a whole, have low correlation with traditional asset classes like stocks... it can help to smoothen the volatility in one's portfolio," added Mr Teo.

Besides diversification, commodities also offer a hedge against inflation, driven by the rising prices of raw materials, such as crude oil and metals.

Commodities are also a window for tapping into the growth potential in the emerging markets of BRIC (Brazil, Russia, India and China), noted Mr Teo. "As these countries develop and urbanise, there's a high demand for raw materials to build infrastructure.

With a growing population, agricultural commodities will also be in demand," he explained.

However, he noted that a recent slowdown in China's economy has also dampened the demand for copper, which is needed to support the country's manufacturing industry.

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