How to Invest in Commodities: The Key Things You Need to Know
Commodities have been traded for thousands of years. If you’re thinking about them as an investment option then learn how to invest in commodities right here.
Learning how to invest in commodities is, in essence, learning to invest in the things that make the global economy work.
Small farm towns throughout the American Corn Belt come alive before the morning sunrise. Tractors powered by massive diesel engines roar to life. At a farm near Wichita, Kansas, a combine operator turns north and begins the harvest.
Six hundred miles southwest in Odessa, Texas, an oil field roughneck stands on a drilling rig. The sun peeks up over the desert landscape as he conducts the day’s first inspection. The rig is low on its production numbers, and he’ll need to find out the cause.
Corn has been turned into fuel for both man and machine. Oil is not only used for fuel, but also to the build plastics used in consumer and industrial products. These are two commodities that have become staples in modern life.
Why Buy Commodities?
Because of their ever-growing need, many investors add commodities to their portfolios. Would you like to diversify your stock holdings? Investing in commodities may be a good move for you. Here are the key things you need to know about why and how to invest in commodities.
Commodities are generally materials produced from farming, drilling, or mining. They have been one of the hallmarks of every civilization in human history. Ancient peoples traded a wide range of commodities, from spices to coral. Commodities are uniform in quality and in use regardless of who is producing them.
As world populations and trade markets grow, demand for commodities generally rises. When more countries advance, more commodities are required. Even though price fluctuations occur, commodities have an intrinsic value as tangible goods. Thus, these products are often at the center of trade markets.
Characteristics of Commodity Investments
Supply and demand driving commodity markets at the heart. Many commodities are resources that have existed for centuries. Supply and demand found a balance long ago.
But supply disruptions, such as war and natural disasters, can lead to price spikes. Sudden changes in demand can affect price in markets where production is hard to adjust. For example, a bitter, cold winter can drive up demand for natural gas and heating oil.
Make Direct Investments in Commodities
The most direct way to invest in a commodity is to buy a quantity of it outright. You will need to find a source to buy it from. You will then also have to find a place to store it. Finding a buyer and handling the logistics of delivery is also required. This can prove to be an intensive process that results in very minor gains.
Buy Stock in Commodity-Producing Companies
Stocks are one of the easier ways to invest in commodities. Instead of investing in the commodity itself, you invest in a related company. When considering how to invest in commodities, think of the industry as a whole. For example, investing in a company that builds turbines is a way to invest in hydropower.
Investing in stocks is easy when using a brokerage account. It’s usually easy for you to get information on a company’s financial situation. Stocks can be bought and sold rather quickly, making them a more liquid asset than many others. A company’s stock price is not always tied to the price of a commodity. Company-related issues may decrease a stock’s value while the commodity’s price rises.
Invest in Commodity Futures Contracts
Futures contracts are often used as an alternative to purchasing commodities outright. These contracts are agreements to buy or sell a specific quantity of a commodity. This takes place at a specified time and at a given price. These contracts are purchased through a stockbroker or a special futures brokerage account.
Your hope as the buyer in a futures contract is that prices will go up. You’ll receive your product at the price negotiated, but the goods will have a higher value. Sellers on a contract hope that prices will go down. The seller benefits if receiving the agreed upon price for a commodity that now has a lower value. Big profits can be had if you’re on the right side of a futures contract.
These contracts can be difficult for investors who are not major players in the market. Often the contracts need a large investment. For example, when it comes to oil investing, airlines and trucking companies greatly influence the futures markets. Because of the speculation involved, futures contracts can be risky for inexperienced investors.
Buy Exchange-Traded Funds
Exchange-traded funds share the pros of direct investment and omit some of the cons. Most commodity ETFs let you buy and sell shares in more manageable quantities. But there are often added fees. The structure of an ETF can be very complex.
Some funds try to give returns linked to the returns of the commodity. But others only provide indirect exposure to pricing that obscured company stocks offer. Others track an index of many commodities and try to offer a way to play the whole commodity industry.
Invest in Mutual Funds
Mutual funds can be another method used for investing in commodities. Diversification is built into the design of a mutual fund. Investment advisors manage the funds as well. This allows you to lower your risk. The investment also has similar liquidity when compared to stocks. It may be a good start for someone learning about commodities investing.
Mutual funds are not without disadvantages. Having the account managed by professionals comes along with associated fees. Your money is also not directly invested in commodities. Advisors may choose to alter the mix of the mutual fund and you may end up not holding any commodities at all.
How to Invest in Commodities Using Stocks
Once you have the right account set up, you can invest online, over the phone, or in person at a local office. ETFs and mutual funds trade and behave like stocks. Futures have a specific exercise date. You must also choose between various-sized lots. Physical commodity brokers have requirements that alike to purchasing any other good.
Are Commodity Stocks for You?
Whether to invest in a commodity is a decision you should make with your financial advisor. Research specific commodity investments. Diversifying your investments can result in a more stable portfolio.
The combine operator and the oil field roughneck often work long hours. They pour out their sweat on behalf of these precious resources. Knowing how to invest in commodities is knowing how to invest in the fruit of their efforts. You can put your money on that.