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Ask the Financial Expert: Should Commodities Be a Part of a Portfolio?

Ron Joelson •  August 27, 2015 | Your Finances, Ask the Expert

Each month, we book time with some of our company’s top financial brain power to answer questions about investing and your finances. This month we’re talking about China’s impact on our markets and economy, what’s going on with commodity prices and how commodities can play a role in individual investor portfolios.

Do you have a question for our financial experts? Email it to us at: AskTheExpert@northwesternmutual.com

I keep hearing about China and how it’s driving the market down. Why is China affecting my investments?

AskTheFinancialExpertBioRon: China has a tremendous impact on the global economy. I heard a commentator recently mention that the Chinese auto market is bigger than the U.S. and Europe’s auto market combined. So the market is significant; and after the major market correction in the market there, it’s clear that it impacted Australia, and it impacted Canada directly. A lot of these countries that have direct ties were all impacted, and companies with indirect ties were also impacted. Don’t forget, China’s growth rate really helped the global economy recover from 2007 and 2008.

What’s interesting about what happened this time is that it seems that China made a bit of a switch. Instead of coming out and just simply buying shares in the market, which I think the market perceived as a sign of panic, China did more traditional things like looking at lowering interest rates as a way to spur on some lending from local banks. That is perceived in general as a more normal intervention, similar to what the U.S. has done and what we’ve seen from European central banks. I think that calmed the markets a bit and suggests that China may be rethinking its strategy.

That may also be some sign of political turmoil in China. You basically have two factions in China. One faction wants to make changes and reform. The other faction wants to go back to the way things were. So we’re probably seeing the market impact of a little bit of uncertainty over there, but I don’t think that means that there’s going to be a major political change in China. I just think it’s reflective of the different camps that are voicing their own interests.

So, China is a concern.

I also think the commodity markets are reflecting lower growth globally. And frankly, if you were to ask me what the major reason was for the correction, it has a lot to do with the fact that the markets are likely catching up to the realization that global growth is low. We’ve been saying that for some time here.

I think the markets got a bit overheated and excited about the U.S. being a stronger story. But in reality, the U.S. is a good story, not a great story. It’s still a low growth rate environment. I think there’s been a market correction to reflect that fact, and you’re seeing it in commodities, as well. Oil prices are coming down. That’s reflective of both supply and a demand perspective. On the supply side we’ve seen countries make decisions overseas to continue to produce oil at any price because they need to, whereas the U.S. reaction is likely to be some difficult times for oil companies that are going to have to get out of the business if prices stay this low.

As we discuss commodities, how should consumers view them? Should individual investors have commodities in their portfolio?

John: We would typically say if you have a long time horizon, 10 years plus, and you’re diversifying amongst different asset classes, commodities could be one class that you consider. The reason is that with commodities, unlike an individual stock or bond, you’re basically investing in the price of goods like food, wheat, corn, soybeans or cattle. Or you might be investing in energy through commodities like oil or natural gas. Commodities also include metals.

When you think about the U.S. economy and the world economy, as those things slow down and those prices drop, food gets cheaper. That means you can go to the grocery store and spend less, you can fill up your gas tank for less, you can heat your home for less, those are good for the individual consumer. That doesn't look good in individual investor portfolios, but the reason someone may hold commodities is when those prices go up, when there is inflation, holding commodities in a portfolio can be a great inflation hedge. That means as things cost more, the amount an investor can sell a commodity for also increases.

Right now commodities may seem like the unwanted piece of a portfolio. But in the long run they can be a great hedge against unexpected inflation.

Hear more from Ron and John in the “Ask the Financial Expert” podcast, moderated by Mark McLennon, Northwestern Mutual’s vice president of investment product development.

Do you have a question for our financial experts? Email it to us at: AskTheExpert@northwesternmutual.com

The opinions expressed are those of Northwestern Mutual as of the date stated on this recording and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security. All investments carry some level of risk, including the potential loss of principal invested. Diversification and strategic asset allocation do not assure profit or protect against loss. Commodity prices fluctuate more than other asset prices with the potential for large losses and may be affected by market events, weather, regulatory or political developments, worldwide competition, and economic conditions. Investment can be made directly in physical assets or commodity-linked derivative instruments, such as commodity swap agreements or futures contracts.

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