As an average investor, you may have plenty to worry about now — from falling interest rates and money side-pocketed in mutual funds to volatile equity markets.

But there is one way to navigate the uncertainties in the market — by investing in commodities.

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Commodities are a good weapon to diversify risk and boost returns of the portfolio, show data from past 50 years.

In March, as equities fell like ninepins due to Covid-19, the risk-off trade pulled down commodity prices, too. But as sanity returned to the market, the asset class that emerged the winner was gold. Investors with the metal or its derivative in their portfolios have survived the market rout much better. The metal has delivered a year-to-date return of 25 per cent vs the negative 3 per cent in the MSCI World index. However, while gold has always retained a negative correlation with equity and been fairly resilient through market mayhems, the same is not true in the case of industrial metals or oil. Since 2011, a combination of oversupply and weak demand has wreaked havoc with the prices of metals and energy, and they have been drifting lower continuously. The Bloomberg Commodities index is down 60 per cent since the 2011 highs.


That said, there are opportunities in individual commodities that can add to the overall returns of your portfolio. Identifying the arbitrage opportunities in commodity derivatives by yourself, or choosing a mutual fund to do so, can help. While currently only TATA AMC (asset management company) has a fund which takes 25 per cent exposure to commodities, similar schemes from other fund houses are likely to be launched soon.

Here is an analysis of the the link between commodities and equities over the past 50 years to see which commodities are better for diversification and in which periods diversification is effective.

We looked at the correlation between equities and various commodity classes in periods that were more volatile, as captured by the standard deviation in price movement.

We have excluded oil as prices have been very volatile of late.


Gold and equities

Gold has been a safe haven in periods when systemic risk has been high, says the World Gold Council (WGC). Cases in point are: the black Monday of 1987 (September-November 1987), the 2002 market correction (March-July 2002), the great recession of 2008 (October 2007-February 2009), and the sovereign debt crisis in 2010 and 2011 (January-June 2010 and February-October 2011). In all these periods, while the S&P 500 index recorded a negative return, gold price moved higher.


Long-period data show that gold has always enjoyed low or negative correlation with equities most of the times. Since 1971, the correlation between the weekly returns of the S&P 500 index and LBMA (London Bullion Market Association) gold price has been as low as 0.01. Whenever the S&P 500 weekly returns fell more than two standard deviations, the correlation between gold and the index turned negative 0.016. Interestingly, in times of sharper correction in equities, the negative correlation strengthened — in all instances when the S&P 500 saw returns fall by more than three standard deviations, the correlation was negative 0.149.

What is also worth noting is that when equities move up, gold, too, moves up, and the correlation between the two asset classes turns positive. In the period under discussion, whenever the S&P 500 index gained more than two standard deviations, the correlation between gold returns and index returns was positive 0.29. Gold’s positive correlation with stocks during bull phases of the market can be explained by higher spending by consumers with increased disposable income on hand and investors, too, buying the metal as an inflation hedge.


For Indian investors, too, diversifying into gold makes sense. In the 2008-09 financial market crisis, when the Sensex tumbled over 50 per cent between December 2007 and February 2009, gold prices in rupee terms were up about 48 per cent.

The correlation between the Sensex and gold prices in rupee between 1979 and now, on weekly returns, is negative 0.008. When the Sensex’s weekly return dropped more than three standard deviations, the correlation between gold and the Sensex was negative 0.33. The rupee depreciation in such periods also helped gold prices.

Whenever the Sensex declines, the rupee invariably weakens due to FPI (foreign portfolio investor) pull-out of money, and it boosts returns on gold.

If history is a guide, your investments in gold will pay you well in future, too, when equity market returns drop.

In bull phases of the Sensex, however, you need to be careful.

If rupee appreciates due to large-scale FPI buying, it may eat into returns on gold.

Industrial metals and equities

Industrial metals including copper, aluminium and zinc traditionally have had a low correlation with equity. But since the beginning of 2005, the relationship between the two asset classes has turned strong, thanks to increased participation of financial investors in commodity futures. When it is the same set of investors who trade simultaneously in different markets, their ‘risk-on’ ‘risk-off’ sentiment will obviously reflect in prices of all assets across markets. The correlation between the Bloomberg Industrial Metals index and the S&P 500 index based on weekly returns, which was 0.11 between 1991 and 2004, became 0.4 between 2005 and 2009. The relationship between the two asset classes, however, broke after 2011 as the slowdown in the Chinese economy hit demand for industrial metals and their prices started spiralling down. The Bloomberg Industrial Metals index which was quoting at 200 levels in 2011 is now at 110.

Industrial metals are thus not a good choice for portfolio diversification now.


On crunching data since 1991, it is seen that whenever the S&P 500 index falls more than three standard deviations, the correlation between the index and the Bloomberg Industrial Metals has been strong at 0.53.

Agri commodities and equities

While globally, there are agri-commodity exchange-traded funds (ETFs) in corn, soyabean, wheat, sugar and other commodities, in India, you will have to make do with agri-commodity derivatives if you want to invest.

However, like industrial metals, agri-commodities, too, seem to move in the same direction as equities in bear market phases.

Since 1991 — from when we have data on the Bloomberg Agriculture Spot index — the correlation (based on weekly returns) between the agri-commodities represented by the index and the S&P 500 is positive 0.0025.

However, note that when the S&P 500 dropped more than two standard deviations, the correlation between the Bloomberg Agriculture Spot index and the S&P 500 strengthened to 0.19.

So, agri-commodities, too, are not as good a diversification tool as gold for an equity investor looking for protection from market gyrations. That said, those of you wanting to hedge inflation in food prices can do so through contracts of commodities including wheat, basmati paddy, chana , moong and turmeric at the National Commodity and Derivatives Exchange (NCDEX).

How to invest in gold

There are many different ways to invest in gold. You can buy from jewellers as gold coins/bars, from the Centre as sovereign gold bonds (SGBs), or as gold ETFs from mutual funds in the stock market platform. If not any of these, you can even consider taking exposure to the metal through futures/options contract at the Multi Commodity Exchange of India (MCX) or BSE.

Your mode of investment should depend on two factors — cost and convenience. In terms of convenience, buying from jewellers as coins/bars gets the least score. Buying online on stock bourses as ETF or SGBs or futures/options is easier and quicker without the worry of safekeeping it.

If you look at cost vis-à-vis returns, SGBs and derivative contracts in gold score higher. Let us explain. Unlike in gold coins/bars where the jeweller will charge an additional making charge and unlike in ETFs where you have a fund management charge, in SGBs, there is no added cost other than the de-mat charges and the brokerage.

Further, in SGBs, the advantage is that you get a coupon (2.5 per cent) on the face value of the bond, and if you hold till maturity, you get capital gains tax exemption on gold.

Even better is the option of gold derivatives. If you think why should invest in a derivative tool, note that even mutual funds that run gold ETFs are considering investing in gold futures.

In May 2019, SEBI released the guidelines in this respect and permitted MFs selling gold ETFs to invest up to 50 per cent of their assets under management (AUM) in exchange-traded derivatives in gold.

The advantage of investing in gold through the futures instrument is this: Unlike in other instruments such as gold ETFs, where you pay the full value of the quantum of gold you wish to buy, in futures, you pay only a margin amount.

The initial margin may be 5-6 per cent or a little more of the contract value, and you can draw benefits of price appreciation in the metal without investing the full capital.

The capital you save can be invested in other instruments to earn a higher return.

But note that there may be additional margin requirements on futures every day depending on the volatility in the contract. If you want to avoid this trouble, you can choose to invest through option contracts in MCX/BSE.

Unlike futures, where both the buyer and the seller are required to keep margins, in options, only the seller has to park margins with the broker.

Also, in case of options, there is only a small upfront premium payment and no MTM (market-to-market) requirements.

If you do not want to take the pain of direct investment in futures/options, you can take the MF route.

Following SEBI’s guidelines in May 2019 when it allowed MFs with multi-asset schemes to invest in commodities through the derivatives route, TATA Mutual Fund in February 2020 launched a multi-asset scheme.

While SEBI permitted MFs to invest up to 30 per cent of their portfolios in commodities through futures contracts in exchanges, Tata Multi Asset Opportunities Fund invests up to 25 per cent in commodities, 65 per cent in equity and the balance 10 per cent in debt.

Since the scheme has a short track record, there is very little data to evaluate its performance. The fund invests in commodities including base metals and agri-commodities besides gold.

As our analysis shows that the correlation of both base metals and agri-commodities is positive with equities in bear market phases, we are not sure how this fund will do in future.

But that said, the fund manager seems to be taking largely arbitrage calls in base metals and agri-commodities, which assures profit.

Arbitrage trades are where an investor takes advantage of the price difference between contracts in near and next/far-month contracts to lock in profit.


The advantage with commodities is that there can be no default risk. But note that there is not going to be any credit rating like in debt instruments or P&L (profit and loss) statements like in equity that can come handy to judge the future of a commodity.

Be it gold or any other commodity, there are supply-demand fundamentals that play out. You need to be aware of these before buying the commodity.

In gold, the economic policies of countries across the globe, geo-political tensions, the USD exchange rate as well as the USD-INR cross, and inflation trends in developing and developed markets also matter.

But gold is a less risky asset than base metals or agri-commodities, and worth consideration in a portfolio for diversification.

You can invest 10-15 per cent of your portfolio in gold any time. Currently, the metal is ruling at a nine-year high price. If you are not invested in gold, you can make a beginning now.

Start moving small portions of your portfolio into the metal through gold ETFs or gold futures in regular intervals over the next six months.

If you are a beginner in the commodity market, you can choose the MF route to start investing in gold or other commodities without doing it directly.