The investment world is full of an overwhelming number of options, including equities, bonds, exchange-traded funds (ETFs) and more. Commodities may seem like just another one of the bunch, but these products offer a unique way to invest your money in the market. If you have questions about a specific commodity, or you’re new to creating an investment portfolio, it might be helpful to consult a financial advisor.
What’s Considered a Commodity?
Generally speaking, commodities are natural, at least to some degree. So where does the term “commodity” come from? Most of these materials require some form of human interaction, like mining, farming, drilling, building and transporting. Only after this do they become products available on the public and private markets.
Here are a few of today’s most common commodities to invest in:
|Examples of Commodity Markets|
|Agricultural Resources||– Wheat, barley, corn, oats, soybeans|
|Soft Commodities||– Sugar, coffee, cotton, cocoa|
|Renewable Energy Resources||– Solar, wind, hydropower, ethanol, geothermal|
|Non-Renewable Energy Resources||– Crude oil, natural gas, nuclear, coal, propane|
|Livestock||– Live cattle, feeder cattle, pork bellies, lean hogs|
|Precious Metals||– Gold, silver, platinum, palladium|
|Industrial Metals||– Steel, copper, aluminum, iron|
Man-made products are, on a large scale, about as close to replicas as possible. Although this does not apply to the above materials, the market treats all commodities equally. In other words, gold is gold, regardless of the mining company it comes from, and cattle are cattle, regardless of the farm they come from.
Think about it. When you go to the store, do you check where each fruit and vegetable was grown? When you’re filling up at the gas station, do you ask the store clerk which country the crude oil was drilled in? Probably not. This principle is what makes commodities an investable asset, as these products are sold on a global scale under the widely acceptable guise of uniformity.
How to Invest in Commodities
If you’re looking into investing in commodities, there are a number of ways to go about doing so. You can buy commodities in the form of futures contracts and ETFs, as well as indirectly through commodity-linked stocks and mutual funds. Additionally, you can invest in commodity-linked bonds.
These equity investment opportunities, which include ETFs and mutual funds, are inherently diversified, because they follow the performance of a single or multiple commodity index rather than that of a single commodity or company. As desirable as these may sound, not all commodities have an ETF or mutual fund associated with them.
Individual equities remain a simple way for individuals to invest in commodities. Of course, this happens in a more roundabout way. Rather, investing directly in a material or products, stocks and stock mutual funds provide the chance to invest in companies that reside within an industry related to a commodity. So if solar power seems like a great investment to you, you should look into solar panel manufacturers.
Governments offer commodty-linked bonds whose yields depend on the price of a specific commodity or a global inflation index. Historically, these fixed-income securities came with a principal or coupon indexed to the price of a specific good or a global inflation index during times of high inflation.
When it comes to large-scale investing, futures contracts are the best way to purchase materials. These allow businesses and institutions either to prepurchase or presell a certain amount of a material for a future date to avoid the usually risky nature of the commodity market. While individual investors will not engage in this, companies that require a massive lots of a single commodity can benefit hugely from doing so.
One of the most common places where this occurs is with airlines, trucking companies and other businesses within the transportation industry. Because these entities require seemingly unlimited fuel reserves, they will often buy futures contracts at a set price to avoid the price fluctuation that will undoubtedly befall many lower level consumers.
Anyone who is new to commodities, or investing in general, should probably talk with a financial advisor before making any purchases. Lucky for you, the National Futures Association, which regulates the commodity industry, has created the commodity trading advisor (CTA) certification. So make sure that whoever you speak to about this topic is a CTA.
Pros and Cons of Investing in Commodities
As an overall investment type, commodities are reliant on the laws of market supply and demand. This can obviously have its upsides and downsides, as volatility can run rampant with so many outside factors affecting every commodity’s production and sale. Below we detail some of the benefits and concerns of each commodity:
|Stocks||– Extremely liquid investments|
– Investment research is easily accessible
– Tradable through personal brokerage accounts
|– Investments are in commodity-related companies, not in actual commodities|
– Even if the commodity is performing well, a particular company may not be
|ETFs||– Low-fee investment option|
– ETF indexes offer ample protection
– Not difficult to invest in
|– If only a select few stocks are doing well, an ETF may not be significantly altered|
– Not available for all commodities
|Futures contracts||– Most direct way to invest in commodities|
– Possibility for strong returns
– Perform well on a large scale
|– Possibility for heavy losses|
– Minimum deposits necessary
|Mutual funds||– Inherent diversification|
– Managed by investment advisors
– Similar liquidity to stocks
|– Professional management comes with proprietary fees|
– Indirectly invested in commodities
History of Commodities
Commodities have been one of the hallmarks of the trade market for every civilization that has ever existed. In fact, historians can trace the trading of these materials as far back as the Sumerians in 4500 B.C. This involved not only spending currency for meat, crops and more, but also bartering one commodity for another. The strongest civilizations usually had the best developed trade markets, and these products were at the center of them.
As you can imagine, commodities interact with the market in a drastically different way today. The U.S. was introduced to modern-day commodity trading in the mid-1800s via the creation of the legendary commodity exchange, the Chicago Board of Trade (CBOT). In 2007, the CBOT merged with the Chicago Mercantile Exchange (CME) to form the CME Group Inc. Other commodity exchanges and markets have opened around the country, including in New York City, San Francisco, St. Louis and Kansas City.
Early on, the CBOT only offered corn, wheat and other agricultural commodities. Today it has expanded far beyond those parameters, though, with a plethora of other investment options now available.
Bottom Line: Should You Invest in Commodities?
There is no purely right or wrong answer to the question of whether or not to invest in a commodity. Instead, you’ll need to do your own research into specific commodity investments. Only then will you see how well they really fit into your financial plans and ultimate goals. Broadly speaking, those who’ve only recently entered the investing game would be wise to stick to ETFs and mutual funds, as they provide protections through indices and professional management, respectively. Inversely, experienced investors can more confidently invest in stocks and futures contracts.
Tips for Investing
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