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How to Invest in Commodities

How to Invest in Commodities

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Adding commodities to a portfolio provides diversification and can even serve as a hedge against price risk farther up the value chain in certain industries. Energy items such as oil, gas, and coal; agricultural products such as corn, soy, canola, pork, and cattle; and metals such as gold, silver, copper, and platinum all have well-understood market dynamics and relatively simple financial instruments that may be traded.

Many commodities are priced based on market demand and the requirement for additional processing. In a world where many financial assets are derivatives, trackers, and derivatives of derivatives, with multiple layers of market sentiment impacting their performance, commodities can provide a more direct experience. We will look at the primary commodities and how you may use them to meet your investment objectives.

The Key takeaways

  • Investing in commodities can offer investors diversity, inflation protection, and excess positive returns.
  • Investors may encounter volatility if their investments are tied to a single commodity or area of the economy.
  • Commodity prices are affected by supply and demand, as well as geopolitics.
  • Investors have the option of trading commodity-based futures, equities, ETFs, or mutual funds, as well as holding real commodities like gold bullion.
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Investors can obtain commodities in a variety of methods.

  • Physical Ownership
  • Futures Contracts
  • Individual Securities
  • Mutual Funds, exchange-traded funds (ETFs), and Exchange-Traded Notes (ETNs)
  • Alternative Investments

1. Physical Ownership

Owning tangible commodities primarily refers to precious metals. Gold and silver are two well-known commodities that serve as tangible repositories of value. Investors can buy these metals in the form of bullion, which is of standard size and quality. Bullion bars have the closest value to the melt price. Owning precious metals in physical form raises storage, insurance, and liquidity concerns.

Commodities other than precious metals have additional storage challenges because they are generally in bigger quantities and have a shelf life, requiring them to be sold within a specific timeframe. This is why most commodity investors avoid physical ownership. To trade actual commodities, you’ll need to find a reliable dealer and, most likely, a storage facility for your assets.

2. Futures Contracts

Futures contracts allow you to speculate on commodity prices directly. Futures contracts are agreements to buy or sell a certain amount of a commodity at a specific price and date in the future. Investors use leveraged margin accounts to expand their investments with their existing resources. The vast majority of trades are settled in cash. This spares an investor from having to take possession of hundreds of thousands of pounds of sugar or figure out how to market 1,000 head of cattle.

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Opening an account to trade futures contracts can frequently necessitate additional documentation to permit margin trading, as well as a larger account minimum. The specific maintenance margin required in an account varies according to the value of the contract being traded.

3. Individual Securities

Individual equities relating to commodity processing or production can be accessed using a standard brokerage account. You can find the companies by using a stock screener and searching for basic materials or energy companies. To be successful, investors seeking commodities exposure through business shares must first acquire some industry-specific information.

For example, extraction businesses in mining and energy have well-developed procedures for conducting feasibility assessments on reserves, which drives stock value. Larger corporations will have reserves in many regions of the world and phases of development, so the influence of a single feasibility study will be negligible as long as overall operations are profitable. However, a smaller company may see increased price volatility as a result of the conclusions of a single feasibility study.

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4. Mutual Funds, exchange-traded funds (ETFs), and Exchange-Traded Notes (ETNs)

Commodity-based mutual funds, ETFs, and exchange-traded notes are examples of products traded on exchanges that can provide commodity exposure. There are exchange-traded products that are tailored to certain commodities. These investors pool their cash to form a commodity pool. The exact investing mechanism is determined by the fund’s guidelines.

The fund managers might purchase futures, options on futures, shares in the sector, or even buy and hold physical products. Some funds are leveraged, which means they are seeking to offer two or three times the price movement of the commodity they are tracking. This is why it is critical to read the fund disclosures before investing to ensure that the exposure being offered meets your investment objectives.

5. Alternative Investments

Commodities, like real estate, are considered alternative investments because they do not trade in the traditional stock and bond markets. Within precious metals, there is a subclass of alternative investments that are more akin to collectibles than to investments. Bullion coins and jewelry have aesthetic and historical significance, thus they typically sell at a premium to the melt price of the metals they contain. While these are still physical investments that can grow in value, their values are less tied to market pricing. You can buy jewelry in stores and coins directly from the Mint or dealers, but they are more of a collection than a commodity investment.

What Is Commodity Investing?

Commodity trade dates back centuries, predating the exchange of stocks and bonds. It was a vital industry that connected many cultures and individuals. Commodities have been popular investment vehicles since the days of spices and silks, and they continue to be traded on markets today.

Investors looking to enter the commodity market have numerous options. Commodity-hungry investors can either invest directly in the physical commodity or indirectly by purchasing shares in commodity firms, mutual funds, or exchange-traded funds.

Benefits

One of the most significant advantages of investing in commodities is that they help to insulate investors from the consequences of inflation. Generally, demand for commodities is high during periods of high inflation, which raises prices. It’s also a strong wager against the US currency, so when the greenback falls, commodities prices climb.

Aside from the benefits of diversification, commodity investing offers the ability to maximize earnings. Although commodity prices fluctuate due to market factors such as exchange rates, interest rates, and the global economy, worldwide demand remains robust. This has a good overall influence on the stocks of companies that specialize in commodities, which can lead to higher profits for investors.

Unique Risks

Keep in mind that commodities are far more volatile than other types of investments, particularly funds that track a single commodity or sector of the economy.

Investors who trade futures should be aware that they are engaging in speculation. Futures contracts track an underlying commodity or index. This could have an impact on contract performance, resulting in a negative (or positive) differential for the investor.

Futures also have specific risks that must be managed separately from the underlying commodity.

Pros

  • Protect against inflation
  • Diversify a portfolio
  • Hedge against a decline in the base currency
  • Help hedge price risk

Cons

  • Increased volatility when compared to other investments
  • Margin trading in commodities potentially results in significant losses
  • Speculative nature of trading with uncertainty of the outcome

Crude Oil

If you’re thinking about investing in crude oil, you need to understand what drives prices and how to do so. Following production, crude oil is processed into a variety of products, including gasoline, which is used to power automobiles. But it extends beyond only gas. Petroleum-based products include plastics, medications, linoleum, shingles, ink, cosmetics, synthetic fibers, solvents, fertilizer, asphalt, and thousands more.

But what influences prices? Crude oil generally follows the rules of supply and demand. When demand exceeds supply, prices typically rise. When demand falls and supply remains relatively stable, prices tend to fall. For example, when gas is in high demand—say, during the summer driving season—the price at the pump rises, resulting in greater crude oil costs.

Similarly, demand from developing countries like China and India, whose economies are still growing, is driving up costs. Geopolitics has a significant impact on the price of crude oil. Tensions in the Middle East, where much of the world’s oil is produced, might cause oil prices to rise.

How to Invest in Crude Oil

Investing in physical crude oil is not as simple as investing in other commodities; you cannot simply purchase a barrel of oil. As an investor, you may want to examine futures, which are the most direct way to acquire the commodity altogether. However, futures trading may be quite volatile and require a significant amount of funds. Furthermore, they need a high level of education, making them unsuitable for inexperienced investors.

Investors may want to buy equities in oil firms, crude oil mutual funds, or even ETFs. These vehicles, like stocks, trade on exchanges, making them widely available. The United States Oil Fund is one example. It monitors the transportation of West Texas Intermediate light sweet crude oil.

Other possibilities include purchasing shares of mutual funds or energy sector ETFs, which invest directly in oil firm stocks. These options typically carry lesser risks due to their more diverse offerings.

Gold

The gold market is diverse and growing. It is employed in jewelry, and technology, by central banks, and investors, creating a market at various points in the global economy. Historically, precious metals have been seen as secure investments and inflation hedges. When the US currency falls, gold prices will rise.

When demand for gold rises, so does the price, just as it does for crude oil. Furthermore, prices are altered when central banks that own gold opt to diversify their monetary reserves by purchasing more gold.

How to Invest in Gold

Unlike crude oil, investors can acquire physical commodities. Investors who want to own the physical commodity can do so by acquiring gold bullion bars and coins. However, this implies paying to hold it in a deposit box, vault, or other secure location.

Another alternative, just like with crude, is to use a futures contract. Contracts require investors to pay an upfront margin. However, this type of investing does carry some risk. If the price rises, investors will profit; but, if the price falls, the investor may lose their money.

Stocks, ETFs, and mutual fund options are plenty. Investors in gold stocks can choose from exploration and mining firms as well as producers. As is customary, investors should conduct due diligence to determine the operational risks associated with each company.

Gold ETFs, on the other hand, give investors exposure to the precious metal while following its price. For example, the SPDR Gold Shares ETF allows investors to have exposure to bullion without really owning it.

Base Metals

Base metals are widely employed in commercial and industrial applications, including construction and manufacturing. Aluminum, zinc, and copper are excellent examples. They are quite inexpensive, and supplies are generally reliable because they are widely distributed over the world.

However, because they are numerous, prices are significantly lower than for precious metals; however, the increased use of base metals, together with expanding global demand—particularly from China and other developing countries—continues to have a beneficial impact on prices.

How to Invest in Base Metals

Holding on to aluminum, zinc, and copper may not be very beneficial. Because of their low prices, investors would need to hold a large quantity of these commodities to benefit.

Instead, investing in base metals firms like Alcoa or U.S. Steel is an excellent way to get your foot in the door. Furthermore, holding ETFs such as the SPDR S&P Metals & Mining ETF exposes you to companies active in metals and mining.

Compare Top Investment Platforms

Platform  Type  Account Minimum Fees
Merrill Edge Online Broker $0 $0.00 per stock trade. Options trade $0 per leg plus $0.65 per contract
E*TRADE Online Broker $0 No commission for stock/ETF trades. Options are $0.50-$0.65 per contract, depending on trading volume.
Betterment Robo-Advisor $0, %10 to start investing 0.25% (annual) for investing plan or $4/month fee for balances under 20K, 0.40% (annual) for the premium plan
Wealthfront Robo-Advisor $500 for investment accounts, $1 for cash accounts, $0 for financial planning 0.25% for most accounts, no trading commission or fees for withdrawals, minimums, or transfers. 0.42%–0.46% for 529 plans
Empower Robo-Advisor $100,00 0.49% to 0.89%

What Do You Need to Open a Commodities Investing Account?

Opening a commodities investment account is the same as opening a traditional brokerage account. If you only want to invest in commodities through firms and funds, you may simply open a conventional brokerage account because these two investment classes do not require anything extra. If you plan to trade futures and options, you must first establish that your broker offers these choices. Then you’ll normally have to make some further disclosures to ensure you understand the dangers and have enough capital to not lose it all in one deal.

What You Need to Open a Brokerage Account 

To open a brokerage account, you must give some personal and financial information and answer some simple questions.

Personal Information

The personal and financial information contains:

  • Name, Address, and Phone Number
  • Tax ID number (typically your Social Security number)
  • Date of Birth and Government ID
  • Banking details to finance the account.
  • Level of investment experience and risk tolerance (KYC questions)

With online brokerages, the initial step is normally to create an account (email and password) with the broker, and then give further information as part of the onboarding process.

Minimum Deposits

While many brokerage accounts have no account minimums, enabling futures trading in a margin account often requires at least a few thousand dollars held with the broker. Depending on the contracts you want to trade, the actual amount of money required to trade will be greater than the minimum deposit required to activate the account. The account type may affect both the initial and maintenance margins for future accounts.

What You Need to Open a Gold IRA

Gold individual retirement accounts (IRAs) are a sort of commodity investment for retirement. Unlike a traditional IRA, you will need to hire a custodian to store the physical assets. To set up a gold IRA, first open a self-directed IRA, then choose a custodian to administer the account, an approved depository to hold the gold, and a broker/dealer to purchase the gold through. Some gold IRA providers incorporate these services or link consumers to providers in their network.

Personal Information

The documents and information needed are the same as those for investment accounts.

  • Name, Address, and Phone Number
  • Tax ID number (typically your Social Security number)
  • Date of Birth and Government ID
  • Additional KYC questions:

Minimum Deposits

The minimum deposit for a gold IRA is significant. This is partly because an ounce of gold is worth more than $1000, and even smaller coins are worth several hundred dollars. The IRS rules say that only certified coins and bars of gold can be used for a gold IRA, but there is no minimum. While not all gold IRAs promote a minimum, a reasonable amount would be at least $2,000. Other gold IRAs have minimum contributions of $10,000, $25,000, and even $60,000.

Best Gold and Silver IRAs

Company Best For Other Metals Website Features
Augusta Precious Metals Transparent Pricing Silver Educational resources, live chat, spot price charts
Noble Gold Smaller Investors Palladium, Platinum, Silver Educational Resources
Goldco Precious Metals Customer Support Silver Educational Resources, Live Chat, Spot Price Charts
Advantage Gold First-Time Buyers Palladium, Platinum, Silver Educational Resources, Asset Comparison Calculator
Patriot Gold Group Variety of Metals Palladium, Platinum, Silver Educational Resources, Live Chat, Spot Price Charts

Pros and Cons of Commodity Investing

Commodity investing, like all other types of investments, has advantages and cons.

Pros

Commodity investing appeals to investors because it provides an inflation hedge, diversifies a portfolio, and has the potential to generate substantial returns.

  • Inflation hedge: Commodity prices tend to grow alongside inflation. Commodity prices are frequently used as indicators of an inflationary climate. While there may be commodity-specific market situations that contradict overall inflation, such as a bountiful crop, commodities generally move with inflation and can offset the dampening effect of inflation on other assets in an investor’s portfolio.
  • Diversification: Because of their low correlation with financial assets, commodities provide portfolio diversification even when the economy is not inflating. Commodities are influenced more by fundamental reasons such as supply and demand than by employment statistics or central bank policies.
  • Potential for huge returns: Cyclical commodities such as oil, gold, and soft commodities can see large price changes. Commodities are vulnerable to output estimates and global events that disrupt supply systems. These profit prospects are what entice investors to enter the commodities market.

Cons

The drawbacks of commodity investing include a lack of revenue, significant volatility, and external dangers.

  • Lack of revenue: Investing in commodities does not produce yield income like bonds or dividend-paying stocks. The accuracy with which price movements are predicted determines the entire return on a commodity investment.
  • High volatility: Commodities’ market dynamics can change dramatically in response to global events. Wheat prices, for example, rose sharply in 2022 as a result of Russia’s invasion of Ukraine, affecting the wheat futures and options market. Similar consequences were felt in the oil and gas markets as a result of Russia’s status as a key supplier, but they were less severe.
  • External risks: There are numerous dangers associated with commodities over which an investor has no control. In addition to regional conflicts that cause supply disruptions, there are climatic risks such as bad weather at the wrong time, regulatory and political risks that might impede the movement of commodities, supply chain risks, and so on. All of these risks, of course, contribute to the volatility and potential for high gains.

Factors to Consider When Opening an Investment Account

Commodity investment is not available with all brokers. This is especially true for digital investment managers who primarily invest in ETFs and stocks. Futures trading is often available on larger brokers’ and trading-focused platforms. This includes brokers such as Schwab, Interactive Brokers, and E*TRADE, as well as more specialized platforms like NinjaTrader and TradeStation. The following are the most important considerations when starting a commodity trading investment account.

Customer Support

Customer support can vary greatly amongst brokers. Most brokers continue to provide phone and email assistance, while some have incorporated in-platform chat and social media channels for customers to contact them. A few brokers have taken the opposite approach, delivering digital-only customer assistance through FAQs and email contact forms. When it comes to customer service, you want to ensure that the broker can be reached using your preferred way.

Fees

Fees for stocks and ETFs have grown far more competitive, with the majority of brokers costing nothing. When it comes to futures, fees are established per contract and might range from a few cents to a few dollars. While it is tempting to seek out the lowest fee broker for futures, it is critical to assess the overall quality of the trading platform.

Available Assets

While most brokers provide both ETFs and stocks, futures are a more specialized service. If you want to invest in commodities, you’ll generally want to have access to the major futures exchanges, unless you’re only planning to use ETFs.

Security and Reputation

In general, you want to know that your broker is looking out for your best interests and keeping your money safe. At a minimum, you should observe industry-standard security protocols, including two-factor authentication, as well as plans in place to prevent outages and data breaches.

Minimum Deposit

Overall, we prefer brokers with modest minimum deposits to encourage customers to invest. When it comes to futures, however, an investor should have a significant amount of capital, both to enable the margin account and to ensure that potential fluctuations do not destroy their portfolios. Commodity investing is a high-risk activity that should not account for the majority of your investment portfolio.

Research Tools

When it comes to commodities investing, research tools can help you comprehend and visualize market dynamics. Robust trading systems can aid by displaying quotes on charts and evaluating volume and volatility, as well as other essential data such as headlines and calendar events. Some brokers charge for extra data feeds, but competition has driven down total costs.

Common commodities terminology

If you are considering investing in commodities, it is important to understand the terms of the deal. Here are some major phrases used in commodity trading.

  • Commodity: Gold, oil, wheat, cattle, and aluminum are examples of raw resources and unprocessed items that can be eaten directly or processed and resold.
  • Forward price: In a forward contract, the agreed-upon price of an asset is determined now, but delivery and payment will take place later.
  • Futures: An exchange-traded derivative. A future is an obligation to acquire or sell an underlying asset in the future at a defined price.
  • Index performance: Most commodities ETFs, ETNs, and mutual funds follow a commodity index, such as the S&P GSCI. Investors should be aware that indexes do not necessarily correspond with spot prices for certain commodities.
  • Spot price: The price stated for prompt payment and delivery of a particular commodity. This price is exclusively for delivery.

Setting proper expectations

Haworth advises that commodities should only play a small position in your portfolio, maybe serving as a tactical strategy in certain economic or market conditions. “Broad commodities probably shouldn’t be part of a long-term portfolio strategy,” Haworth said. “You are not adequately compensated for the risk.” They may produce equity-like returns but with significantly higher volatility and unpredictability.”

What Are Commodities?

Commodities are the basic, or simplest, forms of inputs that are processed to produce energy, food, consumer products, and so on.

Metals are an example of a commodity, and they represent a class of commodities with more complex dynamics. Many metal commodities are widely known. Gold is traded as a commodity and is frequently utilized as a hedge or haven during financial market downturns. Silver has a similar hedge angle and shares some characteristics with gold, such as collectibility and jewelry, but it also has industrial applications that influence its demand.
More common metals, such as copper, see an increase in demand when the economy grows, as they are predominantly used in industrial applications. Steel is traded as a commodity while being a value-added form of iron. Steel is a commodity in terms of hedging and financial exposure that market participants want due to its numerous applications.
Metals aren’t the only commodities in which the market has multiple versions of the same input. Sugar, a soft commodity due to its perishability, is traded under the names Sugar No. 11, Sugar No. 16, and White Sugar. Sugar No. 11 is the raw product standard, whereas Sugar No. 16 has a market nuance in that it is intended for consumption in the United States, and White Sugar refers to the more refined product that is used in other products.
Although many commodities, such as metals and sugar, travel around the world, the actual volume of trading varies greatly and may exhibit seasonal variations. The amount of copper commodity contracts, for example, is frequently many times that of agricultural soft commodities such as soybean oil. Commodities that are less widely traded sometimes require more effort to grasp in terms of market dynamics and pricing pressures, but gaining this specialized knowledge can make a significant difference for investors and traders trying to profit from global input trading.

Why invest in commodities

  • Commodities may reduce portfolio volatility. Weather, politics, and global production can all have an impact on commodity returns, hence there has been little historical link between commodities and traditional investments. As a result, commodity returns may contribute to lower volatility in a diversified portfolio.
  • Commodities can serve as a hedge against inflation. Commodity prices frequently track inflation and may provide a buffer against the effects of rising prices.
  • Commodities can be tangible assets. Hard commodities, such as gold, may be used as a store of value. This is especially true when a baseline amount of demand exists. As demand increases, prices may climb.

What Is Commodities Investing?

Commodities investment simply involves increasing exposure to commodities as an asset class. This could occur directly, as with tangible assets such as gold or silver bullion, or indirectly, through financial contracts traded on exchanges. Options and futures are examples of financial derivatives, as are commodity-tracking funds and shares in corporations that produce or process commodities directly. The primary reasons for commodities investment are the potential for high profits, the inflation hedge, and the diversification it provides to a portfolio because of its low connection with the rest of the financial markets.

What Are Some of the Most Popular Commodities to Invest In?

Some of the most extensively traded commodities are:
  • Precious metals (gold, silver, platinum, etc.)
  • Oil
  • Natural gas
  • Gasoline
  • Corn
  • Wheat
  • Soybeans
  • Cattle
  • Hogs
  • Sugar
  • Lumber

It is worth noting that futures on financial assets currently account for the majority of futures trading volume, as opposed to raw commodities. The equity index, interest rates, and currencies generate greater contract volume than agriculture, energy, or metals.

How Do Leveraged Commodity ETFs Work?

Commodities are also traded through leveraged commodities funds, which are then traded as fund shares. These are frequently separated into bull and bear funds, making it apparent which market position they are taking. Unlike a direct futures or options position, an investor in a bear or bull fund purchases shares of the fund, which uses its available money to conduct direct and indirect trades on the underlying commodity.
A leveraged fund, for example, can hold futures, options, shares, and other financial instruments such as contracts for difference (CFD) to outperform the reference indices. So, for example, a leveraged oil fund that seeks to provide two times West Texas Intermediate Crude Oil (WTI) aims to provide you with two times whatever the short-term price change in WTI.

What Is the Best Way to Invest in Commodities?

The most effective approach to invest in commodities is through commodity exchange-traded funds (ETFs). ETFs make trading easier because they are acquired like stocks, offer diversification, are not traded on leverage like futures, and often have low expense ratios.

When Should You Buy Commodities?

There is no single ideal time to buy commodities. Commodities are a buffer against inflation, therefore purchasing before periods of high inflation is a sound investment strategy; however, knowing when inflation will occur can be difficult.

A commodity should be treated as any other investment, taking into account an investor’s time horizon and risk tolerance. Buying a commodity at a cheap price with a positive future outlook based on fundamentals is always a good long-term investment.

How Do I Buy Oil Commodities?

Individuals can buy oil commodities by acquiring an oil commodity ETF, oil company stock, or oil futures through a brokerage account.

Are Commodities a Good Investment?

Commodities, like any other good investment, are not without hazards. An investor must understand the markets for the commodity in which they desire to trade—for example, oil prices can fluctuate depending on the political atmosphere in the Middle East.

The type of investment is also important; ETFs offer greater diversification and lower risks, whereas futures are more speculative and riskier due to margin requirements. Having said that, commodities, particularly gold, can be used to hedge against inflation and market downturns.

In Conclusion

Commodities, like any other investment, include risks. However, if you understand the various characteristics of the commodity in which you choose to invest, they can be an excellent method to diversify your portfolio.

Other commodities to examine are precious metals (platinum, palladium, silver), lithium, cotton, and food goods such as coffee, corn, oats, wheat, soybeans, and sugar. However, like with any financial decision, conduct your research or seek advice from an experienced broker.

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