Commodities are considered alternative investments because they don't fit into the major categories of stocks, bonds, or cash.
These internationally traded raw materials often represent a relatively small portion of individual investors' portfolios. But they could play important roles, such as hedging against inflation or acting as a safe haven amid market concerns.
Commodities can show large short-term gains, but they can also show large short-term losses. While speculators often try to time these movements, long-term holders understand that the main appeal of these raw materials is their ability to provide diversification.
“Commodity investments have a place in any diversified portfolio and often carry very different risks than traditional stocks and bonds,” said Lucas Keeley, chief investment officer at digital asset management platform Yield Up. “Provide a profile.” “So they're always with us, but they're unlikely to ever turn off the lights.”
Understanding commodity investing
Although each product has specific price factors, one thing they have in common is volatility.
That's because commodities are tied to business cycles. When the economy is doing well or is expected to improve in the near future, industrial commodities such as copper and crude oil can outperform due to increased demand and speculative trading.
Agricultural products such as soybeans, wheat, and livestock are also affected by supply and demand.
Agricultural products can be even more volatile in supply than metals. This is because the reforestation cycle is much shorter than the mine development and life cycle. And unlike metals, agricultural products are always subject to the vagaries of nature, whether it's drought or flood.
Popular products for investment
The top five most popular products are oil, natural gas, gold, silver and copper, said Bob Minter, director of ETF investment strategy at global asset management firm abrdn.
The largest of these is oil, Minter said, but gold is the most popular commodity to hold for the long term because of its role as a risk hedge.
The portfolio of these products will span energy markets, including transportation and home heating. Industrial metals dependent on manufacturing cycles. And precious metals are dependent on financial market dynamics.
What factors affect product prices?
economic circularity
Commodities are particularly volatile investments because most of them are highly correlated to business cycles.
Copper is a prime example of cyclical dependence. The red metal is sometimes called “Dr.” Copper is used in so many industrial applications that it seems as if it has an advanced degree in economics.
world politics
“Your risk profile depends on what you invest in,” Kiley says. “Oil, for example, is highly influenced by world politics and can often see significant price increases in response to tensions in oil-producing regions.”
demand and supply
“The price of oil, gold, silver, copper, etc. is based solely on supply and demand,” said Stephen Connors, president of Connors Wealth Management. “This can increase risk, especially if supply exceeds demand. Shortages of goods can cause prices to rise significantly.”
However, gold is affected by supply and demand in very different ways than industrial metals or energy commodities. Supply is heavily influenced by mine production. However, demand is often driven by the economic interests of central banks and investors rather than the raw demand of industry.
industrial use
Other metals such as silver, platinum, and palladium also serve as precious metals for investors. But they also have much wider industrial applications than gold, giving the yellow metal a unique role in the global financial system and investors' portfolios.
One of the biggest factors influencing commodity investment is economic activity in China. That's because the Asian country's huge population and role as a major global manufacturing center mean it's a huge source of demand for industrial metals, coal, soybeans and many other goods. It is also a major center of demand for gold.
“More than 50% of global commodity demand is generated within China, making the outlook within China important to the direction of commodities,” Minter said. “The current consensus is that China's economic growth rate is 4.6%, which is far from a recession.”
Different ways to invest in commodities
One of the main ways to invest in precious metals is by physically owning bars or coins. However, these must be stored and insured, reducing the profit from rising prices, which is the only way to make money with bullion.
Still, it would be easier for most investors to store gold in a bank safe deposit box than to store grain in silos.
“It's difficult to physically maintain a diverse commodity position because of things like agricultural devastation and maintaining energy storage,” Minter said.
The key here is to gain exposure to commodities through financial markets. Investors often do this through futures, stocks, and funds, depending on their level of sophistication.
“While most investors access commodity markets through ETFs or sector-specific stocks, professional investors use commodity futures exchanges to trade futures on the underlying assets,” Kealey said. .
futures
All types of products are traded on futures markets around the world, including industrial and precious metals, soft commodities such as cocoa, wheat and soybeans, and energy commodities such as crude oil.
Some of the complexities of futures trading include using margin and understanding contract rollovers in lieu of delivery, which most investors don't want.
“Commodities can be held through … futures ownership. Futures are time-bound contracts, so they must be continually rolled and monitored before expiration,” Minter said.
stock
Most investors probably feel more familiar with buying stocks in commodity companies.
However, buying stocks in oil companies or copper mines comes with risks, and these stocks may lag or outperform the underlying commodity.
“You can own a commodity through commodity stocks, but then you take on the operational risks of the company, such as industrial accidents, labor strikes, and poor management decisions,” Minter said. Ta.
Exploring Commodity ETFs and ETCs
Stock-backed ETF
One way to invest in specific commodity themes while managing company-specific risks is through exchange-traded funds (ETFs) backed by commodity-related stocks.
These financial products wrap a variety of stocks under a single ticker symbol that trades like a company's stock. Mutual funds are similar in that they are both pooled investments, but mutual funds are priced only once per day, whereas ETFs, like stocks, are traded throughout the day. will be done.
“For most investors, the best way to invest in commodities is to take a portion of their portfolio and use mutual funds or exchange-traded funds to gain exposure,” Connors said.
ETFs and ETCs backed by cash or futures
However, commodity ETFs are not limited to stock investments.
Some are backed by physical metal held in warehouses, while others are backed by futures contracts.
Exchange-traded products (ETCs), which trade like stocks, are financial instruments that are essentially asset-backed bonds. Their performance is linked to the performance of commodity futures, or the spot price of the commodity (the price for immediate delivery rather than delivery at some point in the future).
An ETC is structured as a bank-underwritten note secured by a commodity.
The appeal of ETCs and ETFs is that they can provide exposure to commodities without the hassle of storing gold yourself or entering complex oil futures markets, for example.
Risks associated with commodity investment
The main risk of investing in commodities is that volatility does not go your way.
In other words, buying a product with the expectation that the price will rise may not work out if the demand outlook does not go as expected. Alternatively, you could lose money if you short the stock of a commodity producer and that company ultimately outperforms.
We will match you with a pre-screened financial advisor who is the best fit for you.
Answer 20 questions and get matched today. Connect with someone for a free, no-obligation call.
On the Dataalign website
How to trade products
There are several ways to access commodity markets, depending on your goals, time horizon, and risk tolerance.
buy precious metals online
Trading products is as easy as buying coins and bars made of gold, silver, and other precious metals from online dealers like Kitco and BullionVault.
Use a brokerage account
If you're already invested in the stock market, you probably have a brokerage account. Perhaps that's all you need to invest in stocks of gold mining companies or oil companies, or his ETF that holds them under his one ticker symbol.
If you want to trade futures, you may be able to do so with your existing brokerage firm with special approval. There are many online brokerages and trading platforms where you can trade futures.
Futures trading on commodity exchanges
There are many different futures exchanges around the world. For example, CME Group owns a series of exchanges where you can trade copper, gold, corn, hogs, cattle, and many other commodities. Another option is the U.S. division of the Intercontinental Exchange, which allows you to trade commodity products such as coffee, cocoa, sugar, cotton, wheat, canola, coal, and crude oil.
Each exchange maintains a long list of commodity trading products on its website.
To get even more exotic, red beans can be traded on Japanese exchanges, skim milk powder in Singapore, refined terephthalic acid in China, and palm oil in Malaysia.
Frequently asked questions (FAQ)
Among Minter's most popular products, gold had the best return last year, which he said was “influenced by foreign central bank purchases to diversify away from the US dollar.” Stated.
Natural gas, on the other hand, has the lowest returns because it has been “affected by three consecutive extremely warm winters in Europe and two consecutive warm winters in the United States, which have reduced demand for home heating,” he said.
Minter said that while each product is unique, three themes currently dominate the general product outlook.
He said physical inventories are low in many products, investor sentiment is very negative in many products, China is adding gradual stimulus, and the domestic economy is starting to improve. Ta.
“Financial managers are shorting commodities to extreme levels,” Minter said. “History shows that extreme negative positioning can cause significant price increases when normalized.”
