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Gold Implosion Lays Bare Speculators

It’s been a bad run for gold investors … and it’s about to get worse, if you look at yesterday’s 9% slide to below $1,400 an ounce as a harbinger of things to come for gold prices.

But more importantly, the meltdown in gold lays bare the nature of commodity speculation — and why commodities should decidedly NOT be a part of most retail investors’ portfolios.

Gold’s 1980-1981 crash showed how risky the metal could be. Over 30 years ago, the precious metal went from $850 to under $400 in short order. The goldbugs and commodity speculators who had forgotten this volatility just got a painful reminder; London fix prices plummeted from just under $1,900 in 2011 to $1,395 as of yesterday’s close for a 26% drop in about two years.

But while gold is the most obvious commodity play, other investments in this asset class have a similar track record of volatility.

Remember the 2008-2009 crash in oil that shaved $100 off crude in a matter of months? Or how corn prices soared over 50% in about five weeks last year?

Gold prices are just the latest example of how the high-octane commodities market can turn on a dime and leave unwary investors in the lurch.

It used to be that most retail investors couldn’t dabble in commodities even if they wanted to; commodity futures markets were logistically out of reach. But the rise of asset-backed ETFs like the SPDR S&P 500 Gold Trust ETF (NYSE:GLD) to the First Trust ISE Global Copper Index Fund (NASDAQ:CU) to the United States Oil Fund (NYSE:USO) give easy access to investments with a hard link to commodity prices and futures markets.

But just as the financial crisis showed us with complex derivatives that were easy to buy but impossible to understand, just because you can invest in something doesn’t mean that you should.

Retail investors need to be very aware of the risks that come with easy access, and know when they are venturing beyond their depth.

Commodities, from oil to aluminum to grains to silver, are nothing more than raw materials that are based on supply and demand. You may think that means pricing them is easy, since there are no balance sheets to dissect here and just big-picture trends.

But some of those trends are impossible to predict, conflict with other data and change on a daily or even hourly basis.

Take grains like soybeans and corn. One of the biggest factors affecting prices is the weather — drought, an early frost or a wet spring to delay planting. Another is acreage intentions, or plainly the amount of farmland in use. Then there are fertilizer costs, stockpiles from last year and government taxes or subsidies to factor in.

And you thought fundamental analysis of Apple (NASDAQ:AAPL) can be confusing.

Crude oil has a natural and unpredictable risk to it, thanks to oil-rich nations in the Middle East constantly exposed to geopolitical crisis and price-fixing from the OPEC cartel. Copper and steel involve a complicated read of global industrial demand, where gains in orders from housing starts in the U.S. can be offset by poor manufacturing data in China.

And then there’s the currency angle, with dollar-backed commodities losing value as the greenback strengthens and gaining value as it falls.

It all adds up to a simple truth: Investors smart enough to trade the volatile and complicated commodities market commonly do so by trading commodity futures. The “easy access” investments like ETFs are tempting, but the ease of trading belies the truly complex nature of this asset class.

Gold investors just learned this lesson the hard way. Because while many investors think that gold is a store of value or a safe-haven trade or an alternative to cash, that sure didn’t stop the precious metal from cratering almost 10% in one day.

Remember this before you have another commodity investment idea that is a “sure thing.”

For the record, I have “owned” gold via an ETF and I hardly think that there should be a blanket ban on the SPDR S&P 500 Gold Trust ETF or the  iShares Silver Trust ETF (NYSE:SLV). There’s nothing wrong with a little speculation based on sentiment, presuming you’re self-aware and honest about the nature of your trade.

But frankly, that kind of investing isn’t very smart. A host of data shows that buy-and-hold investing in dividend stocks is better for your portfolio than churning in quick trades. So rather than waste time and money on commodities, take a look at major materials stocks with decent dividends as part of your long-term portfolio instead.

If you like extrapolating data, use numbers about auto sales or housing starts to invest in auto stocks or housing stocks — not raw materials like steel and copper. If you think oil may rise, why not by ExxonMobil (NYSE:XOM) and enjoy the stability of a megacap oil company and a 2.7% dividend as a hedge? If you think corn will fall, why not look at cereal companies like General Mills (NYSE:GIS) that would enjoy lower input costs and higher margins, not to mention a 3%+ dividend yield?

It’s less stress and ultimately better for your portfolio to go long in commodity-related stocks than to play the churn in hard commodities.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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