Commodities: What Volatility Means for Your Portfolio

If there’s a silver lining to the recent plunge in commodities prices, it’s the reminder--albeit harsh--that what goes up eventually comes down.

Silver and oil prices have already begun to recover from last week’s startling rout that shaved 30% off of silver prices in one week. Oil, meanwhile, dipped more than 10% in a single day.

Before the selloff, silver was the best-performing commodity, nearing all-time highs of $50-per ounce and rising more than 28% for the year ending in April 2011. Oil prices, which can make or break global economic growth, were also on an upswing.What’s the outlook for silver, oil and other commodities — and what does the volatility mean for your portfolio? Here are answers to some common questions.

What caused silver and oil prices to tank?

It depends on whom you ask. Virtually no one can point to a single cause for the dramatic oil correction; instead, it was likely a combination of factors that culminated in one big market panic.“We had some soft economic data that had been accumulating over the past couple days, which kind of spooked the market,” says Mark Luschini, chief investment strategist at Janney Montgomery Scott. As fears snowballed, investors fled. “Once that elephant gets out of the room, it takes everything else out with it.”

On Monday, a Reuters special report cited a flurry of factors for the plunge in oil prices, pointing to everything from a bearish warning from Goldman Sachs to disappointing employment data.Jim Rogers, author and financial commentator, points to a series of technical events that led to the collapse in silver prices; essentially, higher trading costs prompted investors to flee the market. Rogers says this is simply how the market works: “Whenever you see a big run-up in prices, you’re going to have a sharp cut-back. It’s nothing more significant than that.”

What do lower silver prices mean for me?

Not much, unless you’re in the market for cutlery. “If you buy silver flatware, then yes, the price of your knife and fork is going to go down,” says Rogers. Otherwise, consumers shouldn’t expect to see much impact on the prices of everyday household goods.Will oil prices stay low for long?

Probably not. While you may see some temporary relief at the gas pump, oil prices won’t see a sustained drop, Luschini says.

“At the end of the day, the driver for oil prices is demand, ” he says. “As long as we see global growth and China continues to expand, that combination is going to pull on demand for oil.”What about food prices? Will they remain high?

Yes and no. “The fact that oil is down certainly makes it cheaper to produce food and get food to the market,” Rogers says. But the impact will be limited. Both Luschini and Rogers say the long-term outlook is higher food prices as worldwide demand grows.I have investments in oil and silver. Should I sell?

Nope. “I happen to think the commodity super-cycle that started back in 1999-2000 is likely to continue to advance as long as we see global activity continue to increase,” says Luschini. “Frankly, I would use the opportunity of a sizeable correction to phase into commodities.”Commodities can be so volatile. Why bother investing in them?

For one thing, commodities provide portfolio diversification. Commodities have shown a low correlation to equities in past 10 years, which means they don’t usually move in lock-step with the broader stock market. But that’s not always the case: “When you get dramatic contagion, you see the correlation of commodities spike through the roof,” explains John Cadigan, a strategist on the $400 million Rydex Long/Short Commodities Strategy Fund.

Commodities certainly failed to insulate investors during the financial crisis. The stock market fell 48% from July 2008 to February 2009, while the Goldman Sachs Commodity Index, a dominant commodities benchmark, dropped 71%, Cadigan says.

Even so, Cadigan says there is huge global demand for commodities, especially from the emerging markets with a burgeoning middle class. They are popular, too, with investors keeping an eye on inflation. ”Regardless of how you are consuming commodities, they are going up,” Cadigan says. “The only way to hedge against higher prices is to own them.”