Everything You Need To Know About Investing In Commodities
/Once you've explored most of the traditional investments, you may wish to consider dipping your toes into commodities. It's a great way to diversify and lower the risk of your portfolio. What turns people away from the commodity market in the first place is the misconception that they have to own the actual asset, but that's not true at all. While it might seem a bit complicated at first, there are plenty of deceptively simple ways for you to start trading.
Interested? Then here's everything you need to know about commodities.
What are commodities?
A commodity is any raw material that can be used to produce finished goods. Some examples are oil, iron, and wheat. By investing in commodities, you're trading physical goods, unlike stocks or mutual funds, which are securities that only involve financial contracts.
The prices of commodities are subject to the law of supply and demand, both on a local and global scale. Because most commodities are necessities or integral components to different technologies, their prices rarely plummet. However, there is still a chance of this happening. For instance, crude oil prices reached an all-time low during the start of the COVID-19 pandemic, but then rebounded when vaccine distributions began. As an aside, I am vehemently opposed to using oil as an energy source. I am including it in this article simply for educational purposes.
Every investment comes with some form of risk, and the commodity market is no different. But by diversifying your investment portfolio with staple commodities, you're able to control potential losses and generate a nice reward.
Types of commodities
Commodities can be split into two main categories: hard and soft. Hard commodities are raw materials that are mined out of the ground, while soft commodities are those that are grown or raised.
These can then further be broken down into four subcategories, which are as follows:
Agriculture
Soft commodity. Here, you can find edible crops, such as coffee beans, sugar, and wheat. This also includes non-edible products, like cotton and lumber.
Livestock and meats
Soft commodity. This includes meats, such as that from cattle, hogs, and poultry. Eggs and milk also fall under this subcategory.
Energy
Hard commodity. This encompasses the raw materials in the energy market, such as crude oil, natural gas, and coal. It also includes types of renewable energy, like wind and solar power. Renewable energy is the way to go if you are an investor that cares about Mother Earth!
Metals
Hard commodity. Precious metals including gold, silver, and platinum can be found here. This also covers industrial metals, like iron, copper, and zinc.
How to invest in commodities
When trading in the commodity market, you can choose to get involved in the physical trade of goods. However, most investors opt to purchase via futures or ETFs. These types of commodity investments allow you to trade remotely.
Futures contracts allow you to buy or sell a commodity at a certain price, at a specified date. This is most profitable when the market values of commodities change. However, it takes plenty of research and careful speculation to accurately predict market movements. As such, if you're thinking of purchasing oil futures, you'll need to consider the supply and demand, as well as geopolitical factors. Do note that it will be difficult to account for unpredictable events, such as a pandemic which can trigger oil prices to plummet.
Alternatively, you could invest in ETFs. This is the ideal option for those who want to capitalize on fluctuating prices, but don't want to go the futures route. Just take note that only select commodities have associated ETFs, like silver and gold. Gold ETFs allow you to track the price of gold, giving you insights into future investments such as mining shares, gold futures, and the use of leverage. Additionally, buying a gold ETF rather than actual gold saves you the trouble of having it appraised and finding a legitimate buyer, and the same applies to other precious metals. In general, commodity ETFs require less speculation, making them the more ideal option for new investors.
What's the best commodity to invest in?
Two of the main factors to consider when trading in the commodity market are supply and demand as well as global politics. Both of these have a significant effect on market prices. However, some commodities have proven to be relatively stable despite geopolitical disruptions.
Base Metals
One group of commodities with consistent global demand are metals with industrial applications, such as aluminum, copper, and zinc. Cheaper than other commodities, these are easily acquired worldwide, but their rising demand makes them a worthwhile investment.
Gold
Gold is often regarded as a 'safe haven' by investors, primarily because of its stability in times of economic crisis. This, alone, makes it a smart investment. Its many different uses also lend to its relatively high market price.
My two cents
A diverse portfolio is the best way to thrive in any financial season even if there are market slumps and economic downturns. And the commodity market is one of your best choices if you're looking to put your investment eggs in different baskets.
Disclaimer: the content presented in this article is for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.
