Currency and Commodity “Investing” Has Serious Pitfalls

Monday, September 28, 2009

Attention signIn The Wall Street Journal (September 26/27, page A-1), the article, “Small Investors Make Big Bets on Currencies” highlights how individuals can be enticed into betting on currency and commodity price moves. As the article correctly observes, “One of the riskiest corners of Wall Street is making a push to attract individual traders….”

This move into currencies (and commodities such as gold and oil) happens whenever stocks seem risky and currency/commodity price movements are dramatic. This is the situation today.

The problem is there are serious pitfalls from “investing” in currencies/commodities. We can see these by comparing to common stock investing. Here are three especially large drawbacks:

  • First, unlike investing in organizations where management can create value, there is no such benefit from owning currencies and commodities. These are ingredients used in production and trade. They offer no opportunity for income and gains other than simple supply/demand price change. Therefore, “investing” is simply betting on price movements.
  • Second, unlike stock exchanges, commodity exchanges have significant insider trading presence. The currency and commodity exchanges are designed to offer an efficient marketplace for suppliers and users (insiders) to buy and sell. This means those that are in the best position to know demand and supply conditions are able to convert that knowledge to sizeable positions ahead of others.
  • Third, commodities can be traded with massive amounts of leverage. This helps entice investors with examples of other worldly returns. The article mentions 100:1 leverage, meaning a 1% gain could double your money – and a 1% loss could wipe you out. Using this leverage converts betting to rank gambling. Even teams of PhD’s with sophisticated computers have lost everything trying to take advantage of leverage.

So, currency/commodity “investing” may sound worthwhile, especially in today’s markets, but it is a recipe for underperformance and even ruin.

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