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How to Invest in Commodities

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 wise to consult a financial advisor.

What Constitutes 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 or building. Only after this do they become products available on the public and private markets.

Here are a few of today’s investable commodities:

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.

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.

Ways to Invest in Commodities

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 stocks and mutual funds.

Commodity ETFs are a favorite of investors today because of their reliability. These investment opportunities 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 associated with them.

Stocks 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 mutual funds provides 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.

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 Commodity Investments

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:

Commodity Investments
Investment Type Pros Cons
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

Bottom Line: Should You Invest in Commodities?

How to 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

  • It can be nerve-racking getting into investing without the guidance of someone more experienced. The SmartAsset financial advisor matching tool makes it simple to find a professional, though, as it will pair you up with three advisors in your area depending on your investment needs.
  • Diversification is one of best ways to try and ensure growth within your investment portfolio. This strategy dictates that client assets belong in different parts of the market at the same time. This will help to avoid becoming reliant on a specific investment type for returns. Don’t disregard this. Otherwise, you run the risk of a massive collapse should the market you’re invested in falter.

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Chris Thompson, CEPF® Chris Thompson is a retirement, savings, investing and personal finance expert at SmartAsset. He has reviewed hundreds of financial products and financial advisors in an effort to help people improve their financial lives. Chris is a Certified Educator in Personal Finance® (CEPF®) and a member of the Society for Advancing Business Editing and Writing. He graduated from Montclair State University where he received the Journalism Achievement Award. Chris’ articles have been featured in places like Yahoo! Finance, MSN and Bleacher Report. He lives in New Jersey and is a Mets, Jets and Nets fan.
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