Commodities

Commodities are raw materials that are either consumed or used to build other products. As you can probably imagine, there is an endless list of these resources, but all commodities exist within the three categories mentioned below.

Agriculture

Commonly traded agricultural products such as wheat and coffee as well as livestock.

Metals

Metals are divided into traded metals such as copper and steel and precious metals such as gold and silver.

Energy

This includes commodities such as crude oil and natural gas. The oil market alone is larger than all metal markets combined with crude oil being the most traded commodity in the world.

How To Invest In Commodities

The commodities market has grown significantly since the day’s farmers and miners traded products in the local marketplace. In today’s innovative markets, commodities are either acquired directly, using commodity futures contracts or through investments into commodity ETFs.

Direct Investments

While there is nothing theoretically stopping you from directly purchasing barrels of oil or bushels of corn, the impracticality of actual delivery and inevitable storage issues has ensured that this logistical nightmare is seldom the investment method of choice for private investors.

Commodity Futures Contracts

Commodity traders typically use a brokerage to buy futures contracts. These commodity futures are obligations to buy or sell commodities at a future date, at a price agreed today. Commodity prices can be extremely volatile due to their sensitivity to regional, economic and operational risks. As a result, futures contracts are agreed between buyers and sellers to hedge this volatility risk. Generally speaking, when someone is investing in commodity futures, they’ll never physically take possession of the commodity; it is simply used as a speculative or hedging mechanism.

For example, a producer such as a farmer can sell futures contracts to lock in a selling price for their crop. Conversely, a consumer can buy futures contracts to lock in a purchase price for that crop.

Purchasing An ETF

The cheapest and easiest way to invest in commodities for most private investors is to find an ETF that invests in one, some, or even the entire commodities market, or ETFs investing in companies dependent on specific commodities.

Why Invest In Commodities?

While the volatility of commodities markets may present opportunities, this short-term trading approach is best left to the professional commodity traders given the speculative nature of the investments.

Despite this volatility, the low correlation to the broader market provides diversification benefits. Commodities can also act as an effective inflation hedge. Commodities sit at the epicentre of the global supply chain, ensuring that commodity prices should also increase as inflation rises.

Some precious metals function as a store-of-value play with investors turning to the likes of gold when there is fear in the market, with gold demand spiking as equity markets turn negative.

In summary, commodity investing is cyclical and distinct, with huge disparity between the performance of different commodities depending on the commodity in question and the time frame selected.

Although Gold offers a tried and tested currency hedging play and the return opportunities on offer across some of the more volatile commodities are undeniable, We advise investors to proceed with caution.

If you do decide to take an exposure to a specific commodity, be mindful of the risks involved. Without a detailed understanding of the commodity in question, future price volatility may become all too much to bear.

Those who are not well versed in any particular commodity may be best served investing in a broad-based commodity fund.