Investors often overlook commodities, with many focusing on well-known investment vehicles like stocks, bonds, or real estate. They can be very lucrative if you know what they are and how to invest in the right way.
Anyone paying attention has noticed that the prices of agricultural produce and commodities like oil have increased in the past few years. This increase means that if you had invested in these commodities last year, you would have made a tidy return this year. Even though they often have wild price swings, and investing in them can be a bit of a rollercoaster ride, commodities remain an excellent diversification component for any investment portfolio.
What Are Commodities?
A commodity is a raw material produced through agriculture, processing, or mining and used to manufacture other goods. Commodities are divided into two broad classes: soft and hard commodities.
When you hear soft commodities, you should think of those grown or reared. Think livestock, soybeans, cotton, corn, wheat, and other agricultural products.
Hard commodities, on the other hand, have to be mined or extracted. They include industrial and precious metals like gold, platinum or silver, and energy products like coal, natural gas, and crude oil.
What is Commodity Investing?
Commodities are bought and sold all the time in exchanges, just like shares and stocks. While you can buy and hold physical commodities, that is not always a viable option, especially with agricultural products. However, it can be for precious metals, with gold being a very popular option for buying and holding physically.
By far the most popular way of investing in commodities is investing in futures contracts. Although there are some nuances to understand, future contracts boil down to agreements between producers and buyers for the delivery of specific products at a specific date at a predetermined price.
The contractor profits if the final price is higher than what they had agreed to with the producer. In this case, they execute the contract at a lower price and sell the product at the higher prevailing market.
While it may seem like the seller loses, they profit because they are sure someone will buy their products, regardless of the price. This is a hugely beneficial arrangement, especially if they have a significant amount of product and would not be able to move it profitably otherwise.
There is a lot more that goes into commodity investments, including timing, seasonality, and using different strategies for profitability. Investors can learn more about making commodity investing work for them at jamescordier.com.
How to Invest in Commodities
Apart from buying physical commodities and investing in futures contracts, there are other ways to invest in different commodities.
Commodity Exchange-traded Funds (ETF)
These funds pool money from investors to invest in specific assets, in this case, different commodities. As their name implies, they are sold and bought on exchanges, and their price follows that of the underlying commodities.
ETFs are an excellent option for investors who want exposure to numerous commodities, but do not want to follow and invest in the futures market or own physical commodities. They can take a position by investing in the ETFs and watching their investments.
ETFs of Commodity Producers
What if, instead of following the price of the commodities, you want to follow the commodity producers’ share prices? You can do so by investing in their ETFs. You get the same diversification but exposure to a slightly different type of market.
Many investors do this with ETFs of gold and oil producers. The price of these commodities fluctuates frequently, and so does the share price of the companies that mine them. By investing in their ETFs, you leverage both the share prices and the price of these commodities.
Stocks of Commodity Producers
Lastly, you can invest in the stocks of companies that grow, produce or mine a commodity. Doing this benefits you in two key ways:
- You benefit from their product’s price fluctuation.
- You benefit if the company increases production in the future.
That last benefit is crucial, considering a production increase leads to depressed commodity prices. However, it leads to an increase in share prices because the company is considered more productive in that circumstance.
You should consider commodities the next time you are rebalancing your portfolio. They expose you to new markets and asset classes that other investments do not. They are also an excellent hedge against inflation, can lead to massive profits and are typically not affected by what is happening in the larger market. However, every investment comes with inherent risks, so research and consult a financial advisor to ensure you understand this type of investment beforehand.