Commodities and Precious Metals

Lesson

Commodities are basic goods that are used as inputs in the production of other goods and services. At the same time, precious metals are rare, naturally occurring metallic elements with high economic value. Commodities and precious metals can be used to hedge against inflation and diversify an investment portfolio.

Practice Question #1

Which of the following is NOT a reason to invest in commodities and precious metals?

A) Diversification

B) Inflation hedge

C) Guaranteed returns

D) Speculation

Select an option above to see an explanation here.

A) Diversification is a reason to invest in commodities and precious metals, as they can help spread risk across different asset classes. B) Inflation hedge is a reason to invest in commodities and precious metals, as they can help protect against the loss of purchasing power due to inflation. C) Guaranteed returns are not a reason to invest in commodities and precious metals, as there are no guarantees in investing. D) Speculation is a reason to invest in commodities and precious metals, as they can offer the potential for substantial gains.

Terms

Commodities:: Basic goods used as inputs in producing other goods and services.
Precious Metals:: Rare, naturally occurring metallic elements with high economic value.

Practice Question #2

Which of the following is a way to invest in commodities without physically owning the commodity?

A) Futures contracts

B) Gold bars

C) Silver coins

D) Real estate

Select an option above to see an explanation here.

A) Futures contracts are a way to invest in commodities without physically owning the commodity, as they are agreements to buy or sell the commodity at a predetermined price in the future. B) Gold bars represent physical ownership of the commodity. C) Silver coins represent physical ownership of the commodity. D) Real estate is not a commodity investment.

Historical Example

In the early 1970s, the United States abandoned the gold standard, which led to a surge in the price of gold. Investors who diversified their portfolios with gold holdings could protect their wealth from the following inflation.

Practice Question #3

What is the primary difference between a futures contract and a forward contract?

A) Futures contracts are standardized, while forward contracts are not.

B) Forward contracts are traded on exchanges, while futures contracts are not.

C) Futures contracts involve physical delivery, while forward contracts do not.

D) Forward contracts have no counterparty risk, while futures contracts do.

Select an option above to see an explanation here.

A) The primary difference between futures and forward contracts is that futures contracts are standardized and traded on exchanges, while forward contracts are customized agreements between two parties and are not traded on exchanges. B) Forward contracts are not traded on exchanges, while futures contracts are. C) Both futures and forward contracts can involve physical delivery or cash settlement. D) Both futures and forward contracts have counterparty risk, although it is generally lower for futures contracts due to the involvement of a clearinghouse.

Real-World Example

Investors concerned about potential inflation might allocate a portion of their portfolio to gold or other precious metals. This could be done by purchasing physical gold, investing in a gold ETF, or buying futures contracts for gold.