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Back to the futures: Are gold and oil good bets?

June 05, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Low bank rates have led many investors to search desperately for alternatives. This has been credited with supporting the markets for stocks, real estate and commodities. Lately, though, a couple of high-profile commodities have shown a change in their behavior that investors may want to note.

After a 10-year bull market, gold is going through a severe correction. Meanwhile, oil prices over the past year have done something fairly unusual for them: They've been reasonably stable.

Should either of these developments prompt a reconsideration of oil or gold in your portfolio? There are a few things you should evaluate first.

Gold falls from grace -- somewhat

Gold has enjoyed an epic run in recent years, rising by about 570 percent over 10 years before peaking in the summer of 2011. Gold prices then bounced around for a while, but over the past seven months they have pretty much gone straight down, recently dropping below the $1,400-per-ounce mark. This puts gold down about 25 percent from its peak.

Does this drop in prices make it a good time to get in? It's all a matter of perspective. You can look at the recent decline as an opportunity, or you can take a longer-term view and see that gold is still up by nearly 300 percent over the past decade. Whether you view the current price as cheap or expensive really depends on your time-frame, because the market demand for gold is so prone to speculation that it is difficult to come up with an objective valuation methodology.

One thing you can say about gold prices: They certainly behave like no other investment. If nothing else, that at least gives gold a modest amount of appeal as a diversification element.

Oil achieves new steadiness

Oil is also famous for its erratic price swings, but over the past year it has been unusually stable, staying in a band of about $80 to $98 a barrel. So what about oil as an investment?

Like gold, the price of oil is unpredictable enough to give it some diversification benefit in a portfolio of other investments. In addition, oil prices are often a driving force behind inflation, so if you are looking for an inflation hedge, oil is worth considering. Just be advised that it is not a perfect hedge -- as important as oil is in terms of direct consumption and as a cost factor in other sectors of the economy, it is not the only thing that can cause inflation. In some scenarios, rising prices in one sector can actually push down prices in other sectors.

Still, if a fear of runaway oil prices keeps you awake at night, it might be worth owning some oil futures, especially if you focus on long-term futures so the investment can behave more like a hedge than a short-term trade.

Weighing the risks

There are clearly some potential benefits to owning gold or oil, as both can increase the diversity in your portfolio and oil even give you something of a hedge against inflation. However, when people talk about finding alternatives to low savings rates, it is important to realize that these commodities are worlds apart from savings and money market accounts. Going from guaranteed, interest-producing deposits to volatile commodities that produce no income is a giant leap in risk.

There are times when it makes sense to make that leap. But even then, doing so in very small amounts may be the wisest approach.

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