Commodities are the engines that power the world. Without crude oil, it would be impossible for the current world order to exist. It would be impossible for local and intercontinental travel. Without palladium and platinum, the amount of carbon released to the world would be higher, and without copper, electrification would be almost impossible. Most importantly, without commodities like wheat and corn, the world would starve to death. In this article, we will look at the best way in which you can invest in commodities.
The price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt. Jim Rogers
Types of Commodities
While there are many types of commodities, the most common ones are divided into four. These common types of commodities are:
- Metals. These include commodities like copper, zinc, and aluminum among others. These are also known as industrial or base metals.
- Precious metals. These are rare metals such as gold, platinum, palladium and silver.
- Energy. These are commodities that are primarily used as a source of energy. Examples are heating oil, crude oil, and natural gas.
- Agricultural commodities. These are commodities like corn, soybeans, wheat, and cocoa.
How to Invest in Commodities
There are several ways in which you can invest in commodities. Some of the most common of these ways are:
Invest in physical commodities.
In this, you buy physical commodities like metal and crude oil, store them and sell them later on at a profit. There are many investors who have done this. For example, David Einhorn is known for having a pile of gold at a volt in an undisclosed location. Unfortunately, this method has its own cons, the biggest one being its storage. While you can store gold in a vault, it will take a lot of space to invest in crude oil or grains. There is also the security aspect because the commodities can be stolen easily.
Invest in commodities CFDs
A common way in which most people invest in commodities is through contracts for difference. A CFD is a financial instrument, which is offered by many online brokers. The instrument allows people to buy and sell commodities, without the need for owning them physically.
Invest in Commodity Stocks
An indirect way of investing in commodities is to invest in shares of publicly-traded companies that deal with them. For example, if you want to invest in crude oil, you can invest in a company like ExxonMobil. Similarly, if you want to invest in copper, you can invest in copper mining companies like Glencore and BHP. The thinking is that these companies tend to do well according to the performance of the commodities.
However, this is not always the case. Indeed, we have seen many commodities companies struggle when their underlying commodities are gaining. This is because of the many factors that affect the stock price of a company. For example, a company’s stock might be affected by internal leadership wrangles, a stretched balance sheet, and worker strikes.
Invest in Commodities ETFs
Another indirect method of investing in commodities is by investing in commodities ETFs. A commodity exchange traded fund is created by money managers interested in the sector. Some of these ETFs have the physical commodities while others invest in commodity companies. A good example of a commodity ETF is the VanEck Vectors Gold ETF.
Invest in Commodity Currencies
This is a more complicated method of investing in commodities. Some countries are linked closely to the main commodities they export. As such, their local currencies move in a similar direction to the price of the commodity. Some of the most important commodity currencies are Brazilian real, Canadian dollar, and Saudi Arabian riyal.
What Moves Commodities Prices?
In the previous parts, we have looked at the types of commodities, and the various ways in which you can invest in them. In this part, we will look at the factors that cause movements in the price of the commodities.
Broadly, the main factors that causes movements in most commodities is demand and supply. An increase in supply leads to lower prices while an increase in demand causes the prices to soar. However, as you start investing in the commodities, you need to know more about what affects the demand and supply.
Weather is an important factor in commodity pricing. In the agricultural sector, good weather can mean a bumper harvest, which means that the price of the commodities will decrease. Bad weather such as a drought or a lot of rain could lead to low supplies and higher prices.
Weather is not a factor in agriculture alone. For example, a very long period of winter means that the demand for heating will increase. This leads to a higher demand for natural gas and heating oil, which leads to a higher price. Intensive weather such as hurricanes can cause havoc and hamper the production of key commodities. In the Gulf of Mexico, hurricanes can lead to shutdown of refineries. As a result, the price of crude oil could increase as supplies are affected.
In other commodities like copper and coal, bad weather can hamper production too. ### Global Economy
The health of the global economy can affect the pricing of various commodities. Investors interpret the health of the economy as being a good predictor of demand for commodities. For example, when the global economy is doing good, it means that the demand for commodities like copper increases. For this reason, most commodities tend to react significantly when economic data from key companies like China and the US are released.
The US dollar is a very important currency in the world of commodities. This is because most commodities are quoted in dollars. A good example of this is gold, which is a precious metal without any industrial use. Because of its history, the price of gold tends to revolve around the dollar and the monetary policy from the Federal Reserve. For example, if the Fed tightens monetary policy and the dollar spikes, the price of gold tends to decline.
The political climate in the biggest producers of a commodity could have a major impact on the price of the commodity. For example, if there is war or political uncertainty in a country like Saudi Arabia, it means that the production of crude oil could be affected.
In 2017, the price of copper had a major rally after workers in Escondida mine in Chile went to strike. This single strike pushed the price of copper because this is the biggest copper mine in the world and its strike could lead to a cut of production. As a commodities investor, you need to check out at the leading mines to see whether there are any strikes.
Why Invest in Commodities?
There are several reasons why you might consider investing in commodities. Some of these reasons are:
If you want to have a very diversified portfolio, commodities can help you achieve that. However, you need to ensure that you have done enough research about the commodities.
Inflation tends to reduce the purchasing power of cash. Therefore, investing in commodities can help you remove this risk. This is because the price of some commodities tend to rise when there is inflation.
Some commodities tend to have excellent returns. For example, in 2019, the price of gold has risen by more than 20%. This means it has outperformed stocks.
Hedge against risk
A commodity like gold is known as a safe haven. This is because its value tends to rise when there are risks. Part of the reason why gold price has risen so much this year is that investors believe that there will be a recession in the US in the coming year.
Commodities are excellent investments that you can make. However, as with all types of investments, there are risks involved. For example, there is the liquidity risk of some commodities like lumber. Therefore, you should only dedicate a portion of your portfolio on commodities. The other should be in relatively safe investments like ETFs and index funds.
Crispus is a finance professional with more than a decade experience in the industry. Over the years, Crispus has written in-depth articles on leading platforms like CCN, Marketwatch, and Seeking Alpha. He also runs a Forex education and managed account company called WestEndFx.