Commodity trading can be one of the most exciting parts of the investment portfolio. Because commodities can be quite volatile, an investor that enjoys the dynamic of capitalizing on the big opportunities can use their investments here to play the game hard.
Furthermore, at times of high inflation (like now), commodities act as a hedge, as the correlation between commodity prices and inflation is quite close – see the example graph from Haver Analytics below:
There are also a lot of different options in terms of the types of commodities that you can trade. Rare metals such as gold, silver, platinum, nickel, copper, and palladium, and energy assets like oil and natural gas are the most commonly cited, but there are also entire classes of “soft” commodities, such as agricultural products like sugar, cotton, cocoa, and wheat that can be very attractive investment opportunities. There’s a looming cocoa deficit, for example, which will result in some excellent price gains for people who invest in cocoa commodities.
Investing In Commodities Is Easy
For beginning investors, commodities offer another particular advantage: it’s very easy to get involved in and is comparable to buying and selling stock rather than more complex investment opportunities like supporting entrepreneurship (where you need to find the right companies to invest in, and then invest in them through complex and very hands-on investment processes), crypto assets (which take market volatility to a whole other level), or art (which has big payoffs but generally assumes you understand aesthetics and are deeply researched on the market).
One common option for investing in commodities is Contracts For Difference (CFDs), which don’t involve owning the underlying commodity (so you’re not buying a barrel of oil or bar of gold) but instead allow traders to participate in the price movements of the commodity. However, while we mention these as the term will come up often for commodities traders, they’re not legal in the US.
American investors could dip their toe in the market through futures contracts instead. Futures contracts are legal agreements to buy or sell a commodity asset at a predetermined point of time in the future. When the futures contract expires the buyer is obliged to buy and receive the underlying commodity.
However, for those that don’t want to end up having to store tonnes of cocoa, warehouse bars of gold, or sell-on barrels of oil, there are also Exchange-Traded Funds (ETFs) and Exchange-Traded Notes (ETNs). These are traded just like stocks and allow investors to participate in the commodities market without needing to deal with the headache of ending up with the commodity itself via futures.
Another option is commodity pools. Here, a commodity pool operator (CPO) will gather money from a group of investors and use the pool to invest in futures contracts and options. These run much like businesses, with account statements and financial reports. The benefit to doing this is that a CPO will generally have more money in the pool than a single investor can provide, and they will generally employ a commodity trading advisor (CTA) to make expert recommendations, which is a big assistance to beginning commodities investors in particular.
What To Look For When Investing In Commodities
A wide range of different economic and social impacts can affect the price of commodities and if you are planning in investing in the assets then you’ll need to stay very well aware of the news, because you may need to move rapidly. Just some of the major impacts on commodity prices include:
1) The overall health of the global economy – when things are going well, globally, demand for commodities is higher, and therefore so are prices. During recession periods, manufacturing and consumption decline, softening demand for the underlying commodity.
2) Consumer demand – The best example of this is fossil fuels. As electric cars become more commonplace and affordable, and consumers move to them, the price of oil will decline from softening demand. The price of the rare earth metals that go into lithium-ion batteries, however, will increase significantly.
3) The behavior of the US dollar – as a global marketplace, most commodities are priced in US dollars. When the US dollar weakens against the other major currencies, you’ll generally see the prices of commodities rise.
4) Geopolitical events: When war breaks out, both supply and demand of local commodities can be affected. Sanctions on Russia for the invasion of Ukraine, for example, have disrupted the global supplies of everything from gas to wheat.
5) Climate change: Long-term climate change is expected to have massive impacts on the agricultural sector, as crops struggle or fail, or new ways of farming increase demand for other kinds of crops.
Essentially, if you’re planning on investing in commodities, the best way to make sure it’s profitable is to have a deep understanding of what is happening in those commodities markets, and then time your movements into and out of those sectors to hit the highs and lows of the volatile market.
It is, without a doubt, a riskier investment class than some, and for that reason, very few investors will make commodities their entire portfolio – or even a significant portion of it. As part of a diversified portfolio, however, commodities offer low barriers to entry and are a sector that is friendly to the beginning investor.