The world of commerce and commodities can be a hard one to breach. There is so much to know, and it can be overwhelming to try to tackle it straight on.
To get into the swing of things, let’s start with the basics. To learn how to buy commodities, you need first to know what commodity investing is.
What is Commodity Investing?
To start things off, let’s first figure out precisely what commodity investing entails. In the world of economics, commodities are any fully or partially fungible materials that count as raw resources or agricultural goods.
In essence, commodities are the base parts of all business. They are the materials that form everything and sustain both the economy and people.
In commerce, when people think of investors, they tend to think of stock, bonds, trading, and the ebb and flow of the stock market. The idea is to buy shares when they are cheap and sell when they are high.
Commodity investing works in much the same manner. However, the value of goods is dependent on demand and conditions. If you have invested in potatoes, for example, and disease and drought decimate the potato crops, you will lose a lot of money.
If you invest in a gold mine, on the other hand, and it turns out to be chock-full of gold, you’ll make a lot of money.
The stock market is liable to change with inflation and world events, but the commodity market is more volatile. While the stock market has some cushioning through false demand, commodities are entirely supply-and-demand based.
While the stock market may fluctuate, commodities either exist, or they don’t. People either want them, or they don’t. Investors cannot bolster their commodities by simply exchanging money.
To sum it up, commodities are fungible assets; they have to physically exist to be traded for similar or equal assets. Stocks are all based on numbers and can be divided up and resold any number of times, and the resource will not deplete as they are not physical.
Essentially, commodity investing is dependent on supply and demand, inflation, and the presence of resources.
Benefits and Drawbacks of Commodities
There are three main benefits of commodity investing. The first is portfolio diversification. By investing in commodities, the investor ensures they have a failsafe in the event of a stock market crash or another decline in returns.
As you now know from learning what a commodity is and what investing in them entails, commodities are very different from stocks.
The movements of the stock market will hardly ever affect the value of commodities too much. However, commodities can easily influence stocks.
The second benefit of investing in commodities is that they are relatively safe against inflation. While the stock market usually suffers during periods of inflation or a drop in currency value, commodities flourish.
Inflation signals demand, and when demand goes up, so do the prices of raw materials, and by extension, the returns for commodities investors.
The final benefit that draws investors to commodities is the chance for good financial returns. As commodities are a supply and demand-based resource, it is a safe bet to invest in things that are in high demand.
Crude oil, for example, is almost always in demand. During the drop in gas prices a few years back when there was a surplus on oil, savvy investors snatched up oil on the cheap and sold it off for a higher price when the demand came back.
The biggest drawback to investing in commodities is that they are more volatile than other investments. As you may have noticed with the above example, there was very little to indicate the drop in the need for oil before it happened. People who were heavily invested in it at the time suffered a loss.
Overall, commodity investing is a fabulous way to make money and safeguard against disaster, so long as you can get in and out at the precise time.
Types of Commodities
Now that we’ve covered what commodity investing is and why you may or may not want to participate in it, let’s take a look at the types of commodities you can invest in.
Unrefined resources and agricultural goods are too broad a category, so let’s start by breaking that down into four subcategories.
Each of these categories falls into either hard or soft commodities.
Metal – Hard Commodities
This category includes all the raw products of mining like gold, silver, copper, aluminum, etc. this does not include gems like diamonds as they tend to fluctuate on a different scale than raw resources.
Energy – Hard Commodities
This category includes all the things you think of as non-renewable resources like crude oil, coal, natural gas, ethanol, and propane. These are the finite resources that we rely on for many forms of energy.
Livestock – Soft Commodities
The livestock category includes live animals, meat, and animal by-products. All things animal, right from a live cow or sheep, to a side of ribs, milk, eggs, and even manure, are considered livestock commodities.
Agriculture – Soft Commodities
Agricultural commodities are the plant-based equivalent of livestock commodities. They include crops like wheat and corn, coffee beans, cotton, and lumber.
How to Buy Commodities
Now that you know all there is to know about what commodity investing involves, let’s take a look at how to buy commodities.
There are four main ways most investors buy commodities. Some are better suited to different products, while others are better for experienced investors.
You can also use all investing methods to help diversify your portfolio and protect against loss.
Let’s start with the basics. What are futures?
Futures are set contracts that facilitate the buying or selling of an asset at a predetermined time and price.
For each commodity, there are preset contracts that determine amounts. For example, one futures for corn accounts for 5000 bushels of corn. Likewise, one gold futures is a contract for 100 troy ounces of gold.
Commodity futures are a complex and advanced way to invest, but they can be quite lucrative. The initial contract does not cost very much, and depending on the worth of the commodity at the end of the contract, you can make a great deal.
The biggest issue with futures contracts, aside from their complexity, is that they can have extreme results. Getting into a futures contract investment does not cost much initially, but depending on how the value of the commodity changes, you can end up with huge losses.
Essentially, as the value of the given commodity, let’s say gold, increases, the value of your investment does too. Eventually, you make a hefty profit.
However, if demand for gold goes down and the price drops, you have to cover the margin on the contract. This means you could end up paying a great deal to cover the losses of the guaranteed price.
Luckily, the value of commodities rarely drops significantly, especially for items like gold.
Futures, like other investments, can also be done on an individual or group level. Managed futures funds and commodity pools employ multiple investors to increase the leverage each investor has.
It all comes down to margin loans and leverage with futures. They determine how much of a profit you can make outside of the regular supply and demand.
While futures are done by exchanging contracts and funds, you can also invest in commodities by physically owning them. Gold IRAs are a prevalent example.
With gold IRAs or any other form of physical commodity, your investment lies in the tangibility of the object you own. In the case of gold, it is a good way to hold money safe from inflation and market drops.
Gold is almost always steady on the market, and its value only ever increases thanks to inflation. By owning gold, you can ensure that no matter what happens to stocks or the economy, the fluctuation does not affect your commodity’s overall value.
Sure, it may go up and down in value, but you always have that gold bar or bullion. It’s not like someone is chipping pieces off when the market changes. That said, physical commodities run the risk of theft. If you have a safe full of gold, it can be broken into and robbed.
Additionally, some commodities like natural gas, livestock, and oil are hard to own unless you run the company that produces them. Most investors hold shares and bonds that don’t take up physical space. While they might be riskier, they are more space-saving.
Another problem with owning physical assets is that they may be taxable. You might also be forced to sell them lower than you want to if the market is in a tough spot. Insurance is also a consideration for anything that can be stolen or damaged.
Owning physical commodities is a sure way to cover all the bases of your portfolio but can be expensive. Physical commodities are good to have in a pinch but should not make up the majority of your holdings.
Physical Commodity ETFs
ETFs (exchange-traded funds) are a good middle ground for investors looking to own physical commodities without storing or moving them.
ETFs are a superb option for those looking to take advantage of market pricing without physically trading commodities. ETFs are very convenient and easy to use.
This is another place where gold IRAs are an excellent example. For a gold ETF, as the investor, you buy the ETF; this gives you ownership over the underlying gold. However, the gold remains in the company’s storehouse. Multiple investors may own the same commodities together, or you can hold them as an individual.
As you have a stake in the commodity, taxes may be applicable. These types of investments are suited to long-term investors.
A notable benefit of ETFs is that your commodities are kept safer than if you had them lying around your house. However, ETFs are more volatile and prone to fluctuation than stocks. They also don’t include cash flow. The money you make on ETFs comes from the returns after sale.
If you sell when the market is bad, you may not make a significant profit. But if you sell when it is good, you can earn a lot. The chances of a net loss on ETFs are slim thanks to inflation and ever-growing demand. However, there are ups and downs to watch out for.
ETFs are an excellent option for commodities that are hard to store, such as natural gas and crude oil. Buying an ETF gives you more ownership than investing in stocks but negates the need to store or move the commodities.
Commodity Producer Stock
The final way many investors get involved with commodity investing is to back the commodity producer. Investing as a stockholder has several benefits. The first is how normal stocks work; if the company does well through high demand, then you do well.
The second is an increase in production. In this case, if the company is more lucrative – maybe it’s a good year for soybeans or a silver mine finds a new vein – then you see more profits.
This type of investing holds the same market, inflation, and crash risks as any other shareholder position would. It is riskier to invest in a single commodity than a group of stocks.
The profitability of commodities stocks is also dependent on more than just the demand for the commodity. If the company is well run, then this decreases the risk of substantial losses. The value of the company’s stock isn’t directly tied to the current market value of their commodity.
Buying and investing in commodities can be a complex business. There are so many ways to invest. It all depends on what you choose to invest in and how you want to go about doing it.
Whether you are an independent investor or looking to tackle mutual funds, there are many ways to buy commodities.
Commodities are different from stock. They rely more on supply and demand. While they can be more volatile, they can also have great returns.
Futures, physical ownership, EFTs, producer stocks are amongst the best ways to buy and invest in commodities. Which one you choose depends on what commodities you want and what you hope to gain.