Commodities are anything that can be traded in the global markets. That includes stocks, bonds, real estate, and commodities such as gold, silver, oil, etc. They are also known as “investments”, and are an asset class of their own. They are attractive because they can hold their value under adverse conditions, such as inflation or if the economy weakens.
Commodities, stocks, bonds, and real estate all have their ups and downs. You can lose money on any of them. But these assets, and the strategies to invest, are popular for a reason: They can provide a steady income as they mature, and they also provide a hedge against inflation.
Battling low commodity prices and high volatility is one of the biggest challenges for investors during our current economic environment. One of the biggest challenges, however, is how to invest in commodities in a way that’s cost-effective and that can be profitable over the long term.
Commodities are the raw materials required to make the goods that people and businesses consume and utilize on a daily basis. Almost everything, even staples and heavy machinery, is made from raw materials.
Commodities have been securitized in today’s international market to facilitate trade and pricing. Retail investors can now include this fascinating asset class in their portfolios through a variety of vehicles, including exchange-traded funds (ETFs) and futures.
However, because commodities are less well-publicized than other traditional asset classes like equities and bonds, investors are less likely to view them as viable diversification options for their portfolios.
As a result, we created this tutorial on how to invest in commodities so you can learn about the different types of commodities you may invest in, the different vehicles you can use to gain exposure to them, and what to look for when choosing the appropriate instrument for your portfolio.
What Are Commodities and How Do They Work?
The first thing you should know about commodities is that they come in a variety of shapes and sizes, as there are dozens of distinct materials commonly traded on global financial markets, such as soybeans and crude oil.
Here’s a rundown of the most prevalent sorts of commodities you may invest in and trade today to help you understand the market:
Agricultural & Soft Commodities
Agricultural commodities, often known as soft commodities, are those that are harvested and sold as soon as they are plucked from the ground. Wheat, soybeans, chocolate, sugar, barley, corn, and oats are all examples.
However, there is a distinction to be made between agricultural and soft commodities. The former does not require any industrial processing prior to transportation, whereas soft commodities, such as sugar and lumber, are frequently sold after they have been treated into a more uniform shape.
Energy that isn’t renewable
Renewable and non-renewable energy commodities are divided into two categories. Oil, natural gas, coal, propane, and other non-renewable commodities are examples. These commodities’ global reserves are finite and cannot be replaced quickly.
Energy from renewable sources
Solar panels, wind turbines, hydrogen processing plants, and ethanol processing plants are all examples of renewable energy sources.
A livestock commodity refers to a specific portion of an animal that is sold on the international market. This comprises live and feeder cattle, as well as pork bellies and a variety of other products.
Metals of Precious Value
Metals, sometimes known as hard commodities, have their own sub-segment in the commodities market. Meanwhile, precious metals such as gold, platinum, silver, and palladium are classified as a sub-segment of this sort of commodity.
Metals for Industry
Industrial-use metals, such as steel, iron ore, and copper, are another sub-segment of hard commodities that are more widely employed by firms around the world to make products for a variety of reasons.
Which Commodity Should You Put Your Money In?
As you can see, the commodities market is quite large, which makes it a difficult market to comprehend. As a result, investors should do their due diligence on the variables that influence the price of each of these commodities, because the same environment that is favorable to gold may not be favorable to crude oil.
Gold, silver, oil, natural gas, and copper are among the most popular commodities among retail investors. This isn’t to say that retail investors can’t or won’t trade less popular commodities like live cattle and sugar; they just aren’t as popular as the ones listed above.
Commodity Investing Options
Even while there are hundreds of commodities that investors can include in their portfolios, there are only a few vehicles via which they can do so, and we’ll describe how most of the vehicles offered by brokerage firms today work in the next section.
Contracts for Futures
Futures contracts are one of the most common ways for investors to gain exposure to the many commodities traded on the international financial market.
A futures contract offers the holder the right and duty to buy or sell a specific volume of a specific commodity at a predetermined price on a specific date. Futures contracts were created to assist firms in securing a price for the raw resources they require for their operations, while producers could secure a price for the items they gathered, extracted, mined, or otherwise produced.
Using futures contracts, however, investors can speculate on commodities. When compared to other asset classes, the price of these items is regarded very volatile, hence the word speculation.
However, just as a financial model would provide an objective appraisal of a company’s value, a detailed analysis of the processes that govern the price of a commodity might lead to the formulation of reasonable criteria for investing in that commodity.
A monthly expiration date is commonly assigned to a futures contract, and once that date is reached, the person who holds the contract must accept delivery of the goods. For example, in the case of crude oil, the CME Group’s futures contract entitles the holder to 1,000 barrels of crude oil.
The price paid per contract will set the price per barrel, and investors can always sell the contract before it expires to roll their position over to the following month’s contract and avoid having to accept delivery of the commodity.
When using futures to trade in commodities, there are a few dangers to consider. One of them is rollover risk, which is the chance that the price of next month’s contract will be higher than the price paid for the previous month’s contract, resulting in a rollover loss. Liquidity and exercise dangers are two more concerns.
Contracts with Options
An options contract is similar to a futures contract in terms of how it works. The key distinction between both is that an options contract allows the holder the right to exercise the contract after it expires, rather than the obligation to do so.
This means that if the striking price of an options contract is below the price of the underlying asset (call option) or above the price of the underlying asset (put option), the contract will expire worthless (put option).
A call option offers the holder the right to buy the underlying asset at the striking price, but not the obligation, whereas a put option gives the holder the right to sell the contract at the strike price, but not the duty.
Options contracts can be traded in multiples of 100 contracts, with the investor paying a premium on each contract dependent on the current degree of market volatility and other technical considerations.
When an options contract expires, the holder has the option of taking delivery of the underlying asset, which in this example is a commodity. Unlike futures, if an option holder decides to exercise the contract, he or she will have to buy or sell the underlying asset at the strike price.
An options contract must be rolled over before expiration, just like a futures contract, for a retail investor to avoid having to take delivery of the underlying asset. Meanwhile, the same risks that apply to futures contracts also apply to options, as investors may be exposed to rollover risk in a variety of situations.
Option contracts offer various benefits to investors, including risk-reduction tactics, a cost-effective means to long or short equities, and a chance to profit in every market scenario.
Physical ownership of a commodity is another method to include this market in your portfolio. You could, for example, purchase gold or silver bullion, as well as jewelry. The same may be said for the majority of precious metals.
When it comes to precious metals, some companies, such as Bullion Vault, allow you to invest a set amount in gold or silver while they store the things safely and charge you a fee for their services.
Investing directly in commodities such as sugar, wheat, iron ore, or copper may not be practical due to high storage costs and numerous hazards, including damage and theft.
Mutual Funds (MFs) are a type of investment
Mutual funds are a type of investment instrument that allows investors to have exposure to a specific commodity or the entire market, as some of these funds track the value of an index made up of a variety of commodities.
The Gabelli Gold Fund Class A (MUTF: GLDAX) is an example of this, as it invests in both gold and gold mining stocks. This fund has a total of $437 million in assets under management and charges a 1.5 percent annual expense ratio. Meanwhile, to invest in precious metals through this vehicle, investors must put down a minimum of $2,500 and pay a 5.75 percent load.
Credit Suisse Commodity Return Strategy Fund Class A (MUTF: CRSAX), which tracks the Bloomberg Commodity Index Total Return, is another mutual fund that offers exposure to a diverse basket of commodities. This fund has a 1.03 percent expense ratio and a load of 4.75 percent. This fund also has a $2,500 minimum investment requirement.
Because of their higher cost ratios, minimum investment requirements, and load fees, mutual funds are less popular among ordinary investors than exchange-traded funds (ETFs).
ETFs (Exchange-Traded Funds) are a type of mutual fund that (ETFs)
An exchange-traded fund (ETF) is a stock-like investment vehicle that gives investors exposure to a certain asset class or group of securities, such as commodities.
When compared to mutual funds, ETFs have the advantage of being easily traded on an exchange, as well as having reduced cost ratios and no-load fees. Furthermore, the minimum investment required is the cost of one ETF share, although your broker may allow you to acquire a fraction of a single ETF share via fractional shares in some situations.
The Invesco DB Commodity Index Tracking Fund (NYSEARCA: DBC) is one of the most popular commodity ETFs, with $2.7 billion in assets under management and a 0.88 percent annual cost ratio. This fund invests in a variety of commodities to give investors a broad view of the market.
Meanwhile, the United States Oil ETF (NYSEARCA: USO), which provides exposure to crude oil via futures of the West Texas Intermediate (WTI), and the SPDR Gold Trust (NYSEARCA: GLD), which provides exposure to gold, are two commodity-specific ETFs.
Stocks in Commodities
Commodity stocks are equity instruments that provide indirect exposure to the price of a commodity because the underlying firm extracts, exploits, commercializes, or deals in some way with it. Companies that mine precious metals or explore and develop oil wells are two examples.
These businesses’ prices are highly associated with the prices of the commodities they deal with, and investors may either buy individual stocks of firms they believe will do well over time or buy a sector-specific ETF to gain exposure to a diversified basket of these stocks.
The VanEck Vectors Gold Miners ETF (NYSEARCA: GDX), which invests in firms that mine this precious metal, or the SPDR Energy Select Sector ETF (NYSEARCA: XLE), which invests in companies that drill and commercialize oil, natural gas, and other comparable commodities, are two examples.
Commodity stocks give investors exposure to commodities by allowing them to buy shares in firms that produce them.
Investing in Alternatives
Alternative investments are gaining popularity because they provide access to specific commodity market opportunities through structured agreements, private placements, and debt offers.
An investor could gain exposure to the oil market, for example, by investing in a project that involves oil exploration, drilling, and sale. Certain corporations, on the other hand, provide exposure to debt offerings from businesses that primarily deal in commodities, such as a gold mining company’s bond offering.
Although these investments may yield a larger return than the more typical instruments described in this list, they also entail a higher risk and necessitate a much deeper understanding of the market, firm, and instrument to ensure that the projected benefits outweigh the risks.
Commodity Investing’s Advantages (Pros)
- They assist investors in diversifying their portfolios while also having the potential to increase long-term gains.
- In inflationary or recessionary conditions, certain commodities, such as precious metals like gold and silver, may give hedging options.
- Commodities are physical assets that can be easily bought and sold due to their large trading volume and demand on a regular basis.
Commodity Investing Has Its Drawbacks (Cons)
- Investing in commodities is more expensive than other financial assets unless investors utilize the cheapest vehicle available, which is currently ETFs.
- Due to the intrinsic volatility of the elements that drive the price of these things, the commodities market is regarded highly volatile when compared to the equities market. Oil prices, for example, may swing wildly — even to negative territory — as investors saw during the epidemic.
- Trying to figure out what a commodity’s fair value is can be a difficult and time-consuming endeavor. As a result, investors should obtain professional guidance before investing in a single commodity or even an ETF that tracks the entire market.
How to Invest in Commodities: Frequently Asked Questions
We’ve probably covered the majority of what you need to know about the various commodities investment vehicles currently available. However, if you’re still unsure about how they function or whether you should consider include them in your portfolio, here’s a list of the most frequently asked questions we hear on the subject.
What Are the Benefits of Investing in Commodities?
Yes, commodities are dangerous and volatile. However, in the long run, certain studies have demonstrated that their contribution to a portfolio’s return during periods of high inflation is extraordinarily positive.
What Is the Best Commodity Investing Strategy?
Because of their high liquidity and low expense ratios, exchange-traded funds (ETFs) are without a doubt one of the greatest vehicles for investing in commodities. Furthermore, ETFs eliminate the natural storage costs as well as the inherent dangers that come with owning physical assets (i.e., theft, damage, etc.)
What Is the Best Way for a Beginner to Invest in Commodities?
Because of the intricacy of the variables that influence the price behavior of these assets, the commodity market may not be the greatest place for new investors to learn how financial markets work.
In most circumstances, it’s a good idea to get guidance on whether or not it’s a smart idea to include a particular commodity or a basket of commodities in your portfolio.
How do I go about purchasing commodities?
Commodities can be purchased using any of the vehicles indicated above. Most internet brokers now provide access to commodities stocks and exchange-traded funds (ETFs). On the other hand, if you want to buy commodity futures and options contracts, the number of brokerage firms that give access to these instruments is likely to be limited, so check our list of recommended brokers to see which ones currently do.
What is the best commodity exchange-traded fund (ETF)?
If you are looking to invest in the commodity market as a whole, the best alternatives out there include the iShares S&P GSCI Commodity-Indexed Trust (NYSEARCA: GSG), which invests in many types of commodities — although it is primarily exposed to the energy sector. This fund charges an annual expense ratio of 0.85% and manages over $1 billion in assets for investors at the moment.
Another alternative is Invesco’s DB Commodity Index Tracking Fund (NYSEARCA: DBC), which aims to give investors with exposure to a broadly diversified basket of commodities while having a 0.88 percent annual expense ratio and managing over $2 billion in assets.
Due to their low cost ratios, the SPDR Gold Trust (NYSEARCA: GLD), the United States Oil Fund (NYSEARCA: USO), and the iShares Silver Trust (NYSEARCA: SLV) are among the most popular commodity-specific funds among retail investors.
Why Is Investing in Commodities Risky?
Commodity prices fluctuate drastically, and they are influenced by a variety of factors such as the global economy’s overall state, climate, geopolitical happenings, and classic supply and demand dynamics.
Given the difficulty of determining the fair value of a commodity in the setting of a globalized market, non-professional investors may find the challenge of predicting the price of a particular item to be rather daunting.
Now that you understand how to invest in commodities and the advantages and disadvantages of doing so, you should assess the current status of the global economy to see if now is a good moment to enter this lucrative industry.
Keep in mind that including commodities into a portfolio can increase volatility, so you should establish a limit on the amount you allocate to this asset class unless you want to take a wild ride.
Furthermore, commodities produce superior outcomes over lengthy holding periods, which is a strong incentive to consider buying and holding these assets rather than trading them based on brief market swings.
As the saying goes, “the LORD gives, and the LORD takes away. ” It is true that investing in commodities (or any other asset) is not something that gives you guaranteed returns, as it has a very high likelihood of loss. However, when you look at the long term, commodities can give you a good return. At the moment, commodities are at the lowest point in their cycle, which makes them a cheaper option, and you can go long term, which means that you don’t have to worry about short term returns, which is good for investors.. Read more about how to invest in commodities in india and let us know what you think.
Frequently Asked Questions
What is the best way to invest in commodities?
The best way to invest in commodities is through a commodity exchange.
How do I invest in a commodity contract?
To invest in a commodity contract, you must first buy the commodity. Then you can sell it on the market and make money off of its fluctuation.
Is it bad to invest in commodities?
It is not bad to invest in commodities, but it is important to do your research before investing.
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