Question

Financial market commentators often argue that it is unwise to invest in commodities, as they historically have lower average returns and higher risk compared to equities. In light of this evidence discuss whether there is any justification for an investor with mean-variance utility preferences to invest in commodities as opposed to equities?

Answer 1

Yes, it is rightly said that commentators argue that it is unwise to invest in commodities as they historically have lower average returns and higher risks as compared to equities but there are several other benefits of investing in commodities as compared to equities and are as follows :-

1.) Diversification- Usually the returns of commodities like gold are uncorrelated with the returns of equities which helps in making a well diversified portfolio of risk/return.

2.) Inflation Hedge - Prices of commodities like gold and silver tend to increase with the increase in inflation and tend to decrease with inflation so they help in fighting the problem of inflation and help in resolving the risk/ return portfolio.

3.) Economic Disasters - Commodities prices tend to increase in case of event disasters when the prices of equities decrease like in case of a war.

4.) High Returns - Commodities can offer investors higher returns as they have very high volatile risk/return profile. So there is a probability of making higher returns than equities.

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