Commodity Basics
Like stocks, bonds, and real estate, commodities are an important asset class. Commodities are tangible assets used to manufacture and produce goods or services. Specific examples of basic commodity categories include agriculture, energy, livestock, metals, timber and textiles. In the agriculture segment, familiar commodities include cotton, coffee, and wheat. In the energy area, examples of commodities include natural gas and crude oil.

Why Commodities?
Adding commodities to an investment portfolio provides greater diversification and can help to reduce portfolio volatility. Historically, commodities have had low correlations to stocks and bonds. One contributing factor to low correlations is because commodity prices are affected by different risk factors, such as storage capacity, supply, demand, delivery constraints, and weather.

Also, commodities offer a way to protect against inflationary risk and to capture capital appreciation.

How to Invest in Commodities
Investing in commodities can be done by directly purchasing the physical asset, investing through the futures or derivatives market or buying commodity linked investment vehicles. The introduction of commodity linked trusts, exchange-traded notes (ETNs) and other exchange-traded vehicles has made it convenient to obtain portfolio exposure to individual commodities and commodity baskets.

Owning physical commodities presents challenges for many investors. Even though it offers direct exposure to a commodity, the cost of delivery, storage, and insurance can be cost prohibitive.

Using futures or derivatives to obtain commodity exposure is frequently used by large institutional investors that have the resources and tools to monitor such investments. For most individual investors, such commodity based strategies are far too sophisticated and risky.

As such, obtaining commodities exposure via the growing number of exchange-traded vehicles has become a popular alternative. Some of these products are formed as partnerships, commodity pools, or structured notes. These financial tools can track both single commodities as well as commodity baskets. They obtain their exposure by owning the underlying commodities directly or by using a combination of commodity futures and derivatives.

Single Commodities vs. Baskets of Commodities
Owning exchange-traded vehicles tied to a single commodity can be considerably more risky and volatile versus owning a diversified basket of commodities. Below are examples of financial products tracking both areas. Ultimately, investors will have to determine the commodity strategy that best suits their financial objectives.

• iShares S&P GSCI Commodity Indexed Trust (Ticker: GSG)
  The commodities in this index are production-weighted to reflect their relative significance to the world economy. 24 different commodities are represented including corn, gold, live cattle, oil, natural gas, soybeans, and wheat. Crude oil dominates the index's weighting.
  
  
• PowerShares DB Commodity Index Tracking Fund (Ticker: DBC)
  
This Deutsche Bank index tracks a small basket of six commodities using long futures contracts. The amount invested in each of these commodities is weighted and reset annually in the following manner: 35% light, sweet crude oil, 20% heating oil, 12.5% aluminum, 11.25% corn, 11.25% wheat and 10% gold.


• streetTRACKS Gold Shares (Ticker: GLD)
  
The Gold Shares are designed to shadow the price of gold bullion. Each share represents a fractional undivided interest and is based upon 1/10th the price of an ounce of gold. The trust is backed by physical gold bullion in the form of London Good Delivery bars (400 oz.) and is stored in a secure vault.

Commodity Related Industry Sectors
Indirect exposure to commodities can be obtained by owning equity ETFs that track commodity related industry sectors. Examples of specific sectors include agriculture, basic materials, energy, metal and mining, oil and gas, and timber. The drawbacks of indirect commodity exposure using stock ETFs include risks such as corporate and earnings risk.

Taxes
Generally speaking, commodity linked products that utilize futures to obtain their market exposure receive special tax treatment by the U.S. Internal Revenue Service. Regardless of the holding period, 60% of any gains are taxed at the long-term capital gains rate while the remaining 40% of gains are taxed as short term, which are subject to the investor's ordinary income tax rate. For investors in the highest tax bracket, this 60/40 split creates a maximum blended capital gains tax rate of 23%. The tax burden is reduced for investors in lower income brackets.

Also, the taxation of exchange-traded notes (ETNs) is not necessarily the same as commodity linked trusts or ETFs. For general rules, see our educational module on ETNs. Always consult a tax advisor for specific advice.