Commodities are raw or primary products such as gold, wheat, oil, ethanol...etc. Basically anything which has the following characteristics can be considered a commodity: a movable product that is bought and sold; useful or valuable; is a raw material or agricultural product and is available for large scale trading in specialized exchanges.
Investing in Commodities
In buying commodities you are hoping that the price will rise, so that you can sell them for a profit. These raw commodities cover physical product such as (food, metals, electricity) and are traded on regulated commodities exchanges.
Today commodities includes not only agricultural goods, metals and petroleum, but also products such as financial instruments, foreign currencies and stock indexes that trade on a commodity exchange.
Types of Commodities Trading
Spot trading: any transaction where delivery either takes place immediately or soon after. It normally involves visual inspection of the commodity or a sample of the commodity, and is carried out in markets such as wholesale markets.
Forward contracts: an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined today. The fixed price today is known as the forward price.
Futures contracts: a futures contract is a standardized forward contract in which the buyer and the seller accept the terms in regards to product, grade, quantity and location and are only free to negotiate the price today for a future delivery.
Hedging: commonly used by farmers, to insure against poor harvests by purchasing futures contracts in the same commodity. If the farmer has significantly less of its product to sell due to a bad harvest, he makes up for that loss with a profit on the market, because the overall supply of the crop is short everywhere that suffered the same bad harvest.
Commodity ETF: They’re Exchange Traded Funds that invest in physical commodities such as agricultural goods, raw and natural resources and precious metals. A commodity ETF can be focused on a single commodity and hold it in physical storage or invest in futures contracts. Other commodity ETFs look to track the performance of a commodity index that includes diverse individual commodities through a combination of physical storage and derivatives positions.
Commodity ETC: Similar to ETFs, the Exchange Traded Commodities are traded and settled exactly like normal shares on their own dedicated segment. ETCs have market maker support with guaranteed liquidity, enabling investors to gain exposure to commodities, on-Exchange, during market hours. ETCs trade just like shares, and are simple and efficient and provide exposure to an ever-increasing range of commodities and commodity indices.
Risks and Benefits of Commodity Trading
|Commodities are slightly more volatile than the stock market, but they rarely drop at the same time as the stock market||Safe haven or a hedge against inflation|
|Price risk (world prices or the exchange rates could change)||A hedge against destabilizing events or catastrophes|
|Quantity risk (low demand could result in abundance or vice-versa)||In recent years, commodities have outperformed stocks and bonds|
|Cost risk (Input price risk and unexpected costs)||Commodities also move up when stocks go down|
|Political risk (political upheavals, market manipulation)||Commodities are real assets, unlike stocks and bonds|
So how do I trade in commodities? Trading futures is the purest way to trade in commodities. To do so, an individual trading account can be opened either directly with a futures commission merchant or even indirectly through an introducing broker. You can also trade commodities through a managed account, where you give an account manager written power of attorney to make and execute decisions about what and when to trade. The person then will either have discretionary authority to buy or sell for your account or will contact you for approval to make trades.
How do I invest in commodities? For most investors, the most suitable way to invest in commodities is through a mutual fund. They can be purchased through a "natural-resources fund", which buys companies associated with the mining or production of commodities. Or you can buy commodities through a "raw-commodity fund", which actually invests in commodity-linked derivative instruments backed by fixed-income investments.
Commodities Portfolio Diversity
"Do not put all your eggs in one basket" is what portfolio diversity is about. A portfolio diversity (Diversification) helps reduce the risk by investing in a variety of assets (including commodities). If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than if you invested on only one asset. Diversification is one of two general techniques for reducing investment risk. The other is hedging. While diversification relies on the lack of a tight positive relationship among the assets' returns, and works even when correlations are near zero or somewhat positive, hedging relies on negative correlation among assets, or shorting assets with positive correlation.
Best Performing Commodities
Since commodities are based on supply and demand, they tend to be volatile. Therefore, no single commodity could be perfect for all times. But in general, these are some commodities you might consider buying after doing your own research.
Note that the following recommendations were made when the article was written and may not be a good idea to invest on them now.
Gold: Widely seen as a store of value. If you think there will be a high inflation in the future, then buy Gold. That way you can protect against inflation.
Food: The planet’s population is increasing, while food supplies are falling behind. People can live without electronics, jewelry, but they cannot live without food. Food will always be in demand. But do your own research, because the food market is very volatile.
Fertilizers: with the overuse of land resources, fertilizers will always be in demand. Potash for instance, is used in many crops, making it a staple for agriculture.
Silver: Used for jewelry, batteries, bearings, coins, electronics, silverware, photography, solar energy and much more.
Nickel: Used for electroplating, stainless steel and other steel alloys, hybrid car batteries.
Cobalt: Used for laptops, cell phones, , hybrid car batteries, paint-drying agents, super alloys for jet engines.
Tips for investing in commodities
Before buying a certain commodity, examine the past, present, and future. Check the history of the commodity, research the events that triggered a high demand or low demand. See how likely those events could happen today or tomorrow. Weigh the likelihood that similar events could happen in the future which might affect the supply in demand.
These are things to study and examine:
- Volatility: How many steep ups and downs.
- Liquidity: How easily you can sell that commodity.
- Fundamentals: examine the supply and demand.
List of popularly traded commodities: Light crude, heating oil, natural gas, unleaded gas, gold, silver, platinum, copper, lean hogs, pork bellies, live cattle, feeder cattle, corn, soybeans.
Largest commodities exchanges
The following are the main commodities exchanges, where goods are traded:
- CME Group (USA)
- Tokyo Commodity Exchange (Japan)
- NYSE Euronext (USA)
- Dalian Commodity Exchange (China)
- Multi Commodity Exchange (India)
- Intercontinental Exchange (USA, Canada, China, UK)
- Africa Mercantile Exchange (Kenya, Africa)
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