Investing in Commodities

INVESTING IN COMMODITIES

            Commodities have become a more popular investment since the start of the 2000s, but the truth is, most people don’t know that much about them.  Today, we’ll look more deeply into what they are, their benefits for investors, and whether or not you should consider adding them to your portfolio.

            Commodities – A Deeper Look

            A commodity is a basic good or raw material that can be consumed directly, like food, or used to build or create other products.  It can be naturally-occurring, like oil or gold, or it can be an agricultural material, such as corn or livestock.  Commodities run the gamut from precious metals to energy products, but one thing they all have in common is that they are completely interchangeable.  Gold is usually always gold, no matter where it is mined.  Oranges are always oranges, regardless of where they are grown. The quality may vary between producers, but the commodity is always the same, no matter its source.  To be traded, however, the quality of a given commodity must meet minimum standards.  This minimum standard is known as a basis grade.

Investors divide commodities into two groups: hard and soft.  Natural resources that need to be extracted, such as gold, copper, oil, or gas, are considered hard commodities.  Products that are cultivated or ranched, such as corn, soy, wheat or livestock, are considered soft commodities. Here are all of the examples of commodities:

Agricultural Commodities

This group includes crops (corn, soy, wheat), livestock (cattle, hogs) and industrial crops (wool, rubber, lumber.)

Energy Commodities

This group includes crude oil and natural gas, coal, uranium, and ethanol.

Metal Commodities

These include the base metals, such as steel, nickel, tin, and zinc, and precious metals, such as silver, gold, and platinum.

Environmental Commodities

This category includes anything related to non-tangible energy credits, such as carbon emissions.

As the building blocks for other goods, commodities can have an impact several steps down the supply chain. If oranges are scarce in a given year, the price of orange juice will be affected.  If the price of a barrel of oil skyrockets, so will a gallon of gasoline.  These more complicated goods have a presence on the stock market.  Which means that a humble commodity like oranges can actually have a big impact on the performance of a certain industry. 

The Benefits of Adding Commodities to your Portfolio

There are many reasons why commodities appeal to investors, but let’s talk about the most obvious one: they are tangible.  You can usually hold a commodity in your hand – or at least try to.  This is a distinct benefit over stocks, bonds, and mutual funds.  In these times of financial and political uncertainty, when a recession always appears to be looming, a tangible, physical asset that will more or less keep its value is always going to provide some security.

But commodities also appeal to investors because they provide a host of other benefits. 

First is diversification.  Diversification is the idea that our portfolios can benefit from assets that will react differently to the same event.  Commodities work well as a diversifying agent because they tend to move against the stock market.  Typically, their value rises when the value of stocks declines.  Why is this?

 Commodities are an input cost for companies.  An increase in prices of a given commodity can create higher costs for production of whatever more elaborate good is being made.  To use our orange example from before: if oranges are scarce, and therefore more expensive, it usually means that the cost of making orange juice will rise as well.  If a company is suddenly paying more to make its product, this will affect its stock price. If a commodity costs less for a company, then it can make its product for less, which will raise its stock price.  

For this reason, just a few commodities in your portfolio can serve as crucial protection against volatility and loss.  If you have an asset in your portfolio that is certain to rise if the value of your stocks and bonds fall, then you have a hedge against loss. Commodities are that hedge.  And less volatility means more consistent returns over time. 

Another reason to consider investing in commodities is that they may protect your portfolio against inflation.  Here’s how: if prices of goods and services rise, and the cost of commodities increase, then manufacturers will increase supply to offset that cost.  An increase in supply means more commodities are bought and sold, because they are the raw materials needed to make a product.  Their placement at the center of the global supply chain means that they will always be in demand. 

How to Invest in Commodities

As with any asset, commodity investments do not protect against all financial loss.  But they are an attractive option for diversification and long-term investment, and in times of financial volatility, can serve as a useful hedge.       

If one wants to invest in commodities, there are countless ways to go about it.  One can decide to invest in commodities through futures, options, exchange-traded funds, contracts for difference, and other financial instruments. 

Wisdom Trading has been working with clients for over 20 years offering managed investments and self-directed trading.  Participating in a managed account is a great option for the investor who doesn’t have the time or experience to make trading decisions but would like to invest in commodities.  Learn more about the managed programs offered at Wisdom Trading.

As with any investment, you should carefully consider your financial position before deciding to invest, There is a risk of loss in trading futures.