Commodities are increasingly becoming a focus for investors, both locally and globally, due primarily to the rise in commodity prices over the last five years and a bullish outlook going forward.

Meteoric rise in widely known and followed commodities such as gold, copper and even oil has attracted investors especially in developed countries where returns in most asset classes are very low right now.

There are good reasons for this commodity boom. Commodities are getting scarcer as their demand is increasing and the normal economic laws of demand and supply are coming into play. With a rise in population, demand for agricultural commodities (such as wheat, rice, sugar etc) has been on the rise. Coupled with a decline in supply of these commodities due mainly to natural calamities such as extreme weather conditions like the floods in Pakistan, this has caused a boom in food prices, effecting every person.

Similarly, a rise in the prices of base metals (used for industrial purposes) such as aluminium, copper, zinc, lead etc and precious metals (used as a store of value) such as platinum, gold, palladium and silver can be attributed to a rise in demand due to record growth in emerging economies such as China and India. Double digit GDP growth in China and with India not far behind has meant more money flowing in more hands. Incidentally, China and India comprise a total of over 2.5 billion people (approx 37 per cent of the world population) and greater real incomes here has lead to more demand for precious metals such as gold which have traditionally had great symbolic importance in families and have been known to be a source of wealth.

Another important trigger for the recent upturn in commodities is the brewing economic crisis in the West. Currencies, bonds and equities of countries that were considered very strong and stable such as the US, UK and EU countries, have been shaky at best since 2008. Thus, commodities such as gold have attracted a lot of safe haven demand, meaning that investors do not trust the assets of these countries in times of economic turbulence.

Also, with interest rates in these economies being kept very close to zero and money being pumped in to spur economic growth, there are expectations of inflation going forward making a perfect investment case for commodities. Commodities are recognised as an inflation hedge and with the dollar loosing value, commodities priced in that currency move up.

Given the conditions likely to persist for the foreseeable future, there remains a strong investment case for commodities even after such a strong performance. Investment in commodities is a good idea from a diversification perspective as well.

Investors generally go for stocks, bonds (such as government or private bonds), currencies and real estate as their investment choices both in Pakistan and abroad, although investment in the stock market is limited in Pakistan if you look at the number of participants in the equity market.

Investing in commodities can actually be a great diversification tool for investors as major commodities (especially safe haven ones) have been seen to move in the opposite direction as equity markets. This would give credence to the argument that along with stocks, bonds, currencies and real estate, commodities merit an allocation in a portfolio.

Relative allocation amongst these asset classes would obviously depend on the particular investor risk appetite. Thus, an investor willing to take a greater risk on his investments would have a higher allocation for stocks and commodities. A note of caution here, while stocks and commodities may not move in tandem, they do have something in common; they tend to be volatile and require some patience for returns to be realised.

There are many ways that one can invest in commodities. Commodities are quite liquid now and trade on multiple exchanges throughout the world. In Pakistan, the National Commodity Exchange Limited (NCEL) offers commodity investment options. An investor can take both physical exposure or invest in the futures market through an exchange in almost any commodity.

Alternatively, an investor can use mutual funds to invest in commodities. Mutual Funds offer a safe and liquid option for commodity investment as well and the investor gets the benefit of professional management for a small fee.

Globally Exchange Traded Funds (ETFs) attract some of the biggest investors as they offer a passive long-term investment option. At the same time, actively managed commodity funds also exist that aim to outperform their respective asset classes.

—The writer is chief investment officer, KASB Funds