Last Updated: June 12, 2008: 8:07 AM EDT
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Hot commodities (pg. 2)

By Brian O'Keefe, senior editor

Even if you believe that most of the easy gains have already been gotten, there are other reasons for adding commodities to your portfolio. For starters, studies show that the performance of commodities as an asset class has very low correlation to stocks and bonds. That means that when stocks are up, commodities tend to be down. And vice versa. "You have to be prepared for bumps on the way," says Karen Dolan, director of fund analysis at Morningstar. "Commodities can be volatile, but adding them to a portfolio can actually reduce overall volatility."

A second important reason to add commodities to your investment mix - one that's especially relevant to those approaching retirement age - is to offset inflation. "As an investor you are exposed to a variety of risks," says Don Coxe, global portfolio strategist at BMO Capital Markets and another commodities bull. "If you own agriculture and oil, then you put in a built-in hedge for yourself because you're now somewhat independent of rising food and fuel prices."

For both of those reasons a growing number of financial planners and money managers are following the lead of institutional investors and spicing up traditional stock and bond recipes by putting 5% or 10% of a portfolio in commodities. "I think there's a new wave," says Tom Lydon, a financial advisor whose Global Trends Investments in Newport Beach, Calif., manages $75 million. "It's not overly aggressive to propose a 10% allocation at this point."

How do you begin? One way to get exposure, of course, is to invest either in mutual funds that focus on stocks of miners like BHP and energy companies like ExxonMobil (XOM, Fortune 500), or to invest directly in the companies themselves. If you pick the right fund or stock, it can work out great. But because resource stocks are affected by the direction of the broader market, you lose the advantage of not being correlated with equities. During the past year, for instance, Exxon's stock rose less than 5%, while the price of oil doubled. From a portfolio-planning standpoint, it would be better to put your money directly into the hard assets themselves.

Luckily, this is one case in which Wall Street's marketing zeal works in favor of the individual investor. In the past couple of years dozens of new products have appeared that track both broad commodities indexes and narrower slices of the resource world. The main vehicles are exchange-traded funds. ETFs, as they're known, are funds that track indexes but trade like stocks. "It's very easy to build a well-rounded portfolio with just two or three ETFs," says Lydon, who also runs the website

You can start with a single fund that tracks a basket of various commodities. For a basic foundation, Lydon recommends the PowerShares DB Commodity Index Tracking fund (DBC), an ETF that is pegged to the Deutsche Bank Liquid Commodity index. There are also exchange-traded securities that track the energy-heavy S&P GSCI Commodity index, the less concentrated Dow Jones-AIG Commodity index, and the wide-ranging Rogers International Commodity index.

Some of these products are structured in the form of Wall Street's newest fad: the exchange-traded note. Like their ETF cousins, ETNs can be bought and sold freely like stocks. But they are actually long-term debt securities. Essentially, when you buy an ETN you are lending your money to the issuing financial institution in return for a promise that it will pay you the equivalent of the return of a given index. One potential downside is that you are taking on the credit risk of the issuer. (So, for instance, you might want to wait a little while before buying the new Opta ETNs from Lehman Brothers, given questions about the bank's liquidity.) But most experts regard them as a safe and relatively efficient way to invest in basic indexes.

If you're looking for a more specific commodities bet with big upside, the best place to invest right now, say many observers, is agriculture. While the prices of corn, rice, and wheat have spiked recently - and food shortages have sparked rioting in Egypt and other countries - they have only just begun to catch up with the rest of the resources world.

Over the past five years the Dow Jones-AIG agriculture index is up 33%, vs. 59% for the Dow Jones-AIG energy index, for instance. But grain reserves worldwide are at lows not seen for decades. And new strain is causing increased volatility. Earlier this year the price of wheat shot up 61% before correcting. Again, the main driver is Asia's economic growth. "Billions of people are changing the way they eat, adding protein and calories to their diets," says analyst Sean Brodrick of Weiss Research. "That's a demand story you just can't shrug off. We need bumper crops to keep up with what people are eating now." If you're interested in adding some fiber to your portfolio, check out a pair of securities with comically unwieldy names: the iPath Dow Jones-AIG Agriculture Total Return Sub-Index ETN (JJA) and the Elements Linked to Rogers International Commodity Index-Agriculture ETN (RJA).

Strategist Coxe of BMO Capital Markets is also bullish on an old commodities standby: gold. He sees it as a further hedge against both currency risk and the ongoing financial contagion on Wall Street. When investors panic about the prospects of banks, gold - a.k.a. "the one true currency" - tends to rise.

But investors might also investigate another precious metal: silver. Whereas gold touched new all-time highs above $1,000 an ounce earlier this year before pulling back, silver remains 60% below its 1980 record price of $44 an ounce, even after more than tripling over the past five years. Plus, potential new industrial uses for silver in cutting-edge batteries and nanotechnology could add to demand. The two-year-old iShares Silver Trust ETF (SLV) makes it easy to add the metal to your portfolio, but, like many other ETFs, there is an annual management fee. This might be one commodities play where it pays to keep it old-school and buy some coins.

Reporter Associate Doris Burke contributed to this article. To top of page

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