It has long been proven that a diverse portfolio is the best way to minimize risk and maximize profits as an investor. After all, spreading out your assets offers protection against market changes — something that is becoming increasingly important in today’s world. It turns out investing in commodities can be a great opportunity to do just that.
If you have tried your hand at more traditional investments (such as real estate, stocks, or bonds) it can be a good idea to start branching out. Luckily, commodities investing for beginners is not as complicated as it may seem. There are multiple ways for investors to begin seeing profits from commodities, all you have to do is a little research to get started. Let’s go over how to invest in commodities.
What Are Commodities?
Commodities refer to any uniform resources that are considered to be basic goods. A few well-known examples are wheat, corn, and oil. Each of these resources can be used in various ways and are oftentimes in demand all over the world. Trading commodities is a practice that dates back hundreds of years, and today there are even more ways to see profits from commodities. These include exchange-traded funds (ETFs), futures contracts, and options.
There are two main categories of commodities: soft and hard. Soft commodities refer to grown or ranched items, such as rice, corn, soybeans, and livestock. Hard commodities are resources that must be mined or drilled, like coal, gold, aluminum, and gas. This distinction is helpful when searching for investment opportunities.
Despite a global demand for many commodities, there is still some risk involved to be aware of before investing. Every market will be subject to some uncertainties, and commodities are no different. For example, during the COVID-19 pandemic, there has been a dramatic decrease in oil demand. However, by diversifying your assets you can help safeguard your portfolio with commodities and mitigate some risk.
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Types Of Commodities
There are four main types of commodities to be aware of: agricultural, livestock, energy, and metals. Before you learn how to invest in commodities, it is important to know the differences of each. These distinctions can help you identify practical investment opportunities that fit your risk tolerance and financial goals. Here are a few examples of each:
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Agricultural: These commodities essentially refer to crops within the agricultural sector. Popular agricultural commodity examples include coffee, cocoa, wheat, cotton, sugar, and corn. The risks associated with these commodities center around seasonal and weather-related changes. While profits are typically driven by population growth and limited agricultural supplies.
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Livestock: The other half of what many people typically associate with agriculture is livestock. This type of commodity deals specifically with cattle, chickens, hogs, and other animals. While there is less uncertainty when compared to crops, there are still some risks involved in livestock commodities.
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Energy: Energy is one of the most well-known types of commodity and includes crude oil, natural gas, gasoline, and heating oil. Demand for energy-related products has for the most part increased consistently throughout history as a result of development. Adam Ng, the CEO and Founder of Trusted suggests that “energy stocks have been some of the strongest performers in the market to start the year, and while the sector might need some time to consolidate those gains, there are still plenty of good reasons to consider adding shares of a company like Diamondback Energy at this time. It’s an independent oil and natural gas company operating in two segments, the upstream segment, and the midstream operations segment”. Investors should be aware that economic downturns can negatively impact the market for energy-related commodities, as we have seen throughout 2020.
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Metals: Metals refer to commodities that must be mined and are often described as either base metals or precious metals. Base metals are used for industrial purposes, such as zinc, steel, aluminum, lead, and nickel. Precious metals typically have higher value and are used for investment or decorative purposes. Precious metals include gold, silver, platinum and ruthenium.
What Is Commodity Trading?
Commodity trading is the practice of buying and selling various resources. The practice is hundreds of years old, though it looks a lot different now than it once did. Commodity trading used to focus on materials and spices, which facilitated cultural exchange around the world. Today, investors can not only purchase physical commodities, but they can also buy shares in commodity companies, ETFs, or mutual funds.
When managed correctly, commodity trading can be a great way to diversify an existing investment portfolio. This is because commodities often benefit from a steady demand, allowing investors to maximize their returns. While commodities are subject to some market fluctuations, commodities can offer protections against inflation or times when the U.S. dollar declines in value.
The Supply & Demand Rule
The principle of supply and demand is the basis of commodity investing. Many commodities are raw materials or basic goods, leaving little variability within each product. Essentially, this means that commodity prices are not impacted by the same factors that dictate other industries such as the manufacturer or type. Instead, the price of any given commodity strictly comes down to market demand. This leaves many commodities vulnerable to market fluctuations over time, like in the oil example mentioned above.
If you want to invest in commodities, it can be helpful to keep up with current events and gain a deeper understanding of the market you are investing in. This is often the best strategy for safeguarding your investment and prepping your portfolio for any big changes.
Lowest Cost Commodities Generate The Most Profit
As a result of unpredictable markets, the best commodities are often the ones produced at a low cost. The reason for this is that commodity industries with high overhead costs are less able to adapt to declining prices. After all, they have higher expenses to cover to make their margins. Commodities with low overhead costs are therefore better able to adapt to fluctuations, as the producers still stand to make money when selling units. Keep this in mind as you research different options and learn about market demand.
Benefits Of Investing In Commodities
The main benefit of investing in commodities, especially if you are coming from the real estate industry, is the opportunity to diversify your portfolio. That being said, there are a number of reasons commodities stand out from other investment types:
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The performance of commodities typically does not correlate with other assets, allowing you to buffer your portfolio. Instead, commodities are impacted by economic and political factors relating to supply and demand.
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Commodities can help you hedge risks from other assets, depending on how you choose to invest. Simply put, you can invest in a commodity that will increase if another asset of yours decreases.
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Investing in commodities is one way to protect against inflation. Commodities typically do not rise at the same rates as other investments, again due to the nature of demand.
Risks Of Investing In Commodities
Unfortunately, there is no perfect investment and commodities are no different. Here are a few risks to be aware of before getting started:
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Commodities can be subject to some unpredictable market changes, such as the COVID-19 pandemic. While following current events can help anticipate changes there is no way to perfectly predict price fluctuations or volatility.
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Commodity investing requires a certain degree of speculation, which makes returns uncertain. In some ways, this can make commodities less friendly towards beginner investors who are unable to predict market changes.
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Worldwide events, foreign government policies, international trade competition and economic conditions are all macroeconomic factors that make impact commodities and could cause your investment to lose value.
How To Invest In Commodities In 5 Different Ways
There are several ways to invest in commodities, each with unique benefits and risks to consider. Investors should research each type before choosing a strategy (or two) for their portfolios. The five main ways to invest in commodities are:
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Buying stocks in companies that produce commodities
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Purchasing futures contracts
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Buying shares in exchange-traded funds
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Using mutual and index funds to trade commodities
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Working with commodity pool operators
How To Use Stocks To Invest In Commodities
Stocks are perhaps the most straightforward method of investing in commodities. To get started investors can simply purchase shares of a company that deals with commodities. For example, those interested in metal commodities could buy shares in a mining company that focuses on gold. This option is especially attractive to investors who are unable to make a large initial investment.
The risks associated with commodity stocks typically center around the companies themselves. Prices may be negatively influenced by business operations or other company-related factors, as opposed to just the actual value of the commodities. Unfortunately, there is not a way to reduce this risk completely but investors can heavily research the companies before purchasing stocks.
How To Use Futures To Invest In Commodities
Futures are a great opportunity to invest in commodities, especially if you are familiar with the market you are investing in and are interested in speculating on price changes. Futures contracts are essentially agreements made to buy or sell shares at a certain time in the future, for a predetermined price. Investors can profit from futures contracts when the value of the commodity changes. This can be done on a short or long-term basis.
Getting started in futures contracts does involve a lot of research on the industry, and is typically not recommended for beginner investors. The reason is that a lot of futures investing revolves around speculation. However, investors can work with a broker or opt for contracts with an option to buy. These methods can help investors who may not be familiar with market analysis benefit from the profitability of futures.
How To Use ETFs To Invest In Commodities
ETFs are a great option for those who are interested in fluctuating commodity prices but don’t want to necessarily purchase futures contracts. ETFs refer to exchange-traded funds and act as a collection of securities. They can be bought and sold similar to stocks, with prices changing throughout the trading day. Investors hoping to purchase commodity ETFs can do so with the help of an online or traditional broker. It is worth noting that not all commodities have associated ETFs; therefore, investors with a specific commodity in mind may need to look elsewhere.
Using Mutual & Index Funds To Invest In Commodities
Mutual funds can be a great vehicle for investing in companies that deal with certain commodities. While this opportunity does not allow investors to work with the commodity directly, there are several protections associated with mutual funds to consider. For the most part, mutual funds are known for their professional management and liquidity. This makes these funds a great option for investors hoping to profit from the companies that deal with commodities, without directly buying stocks themselves. In many ways, this can be a good gateway into commodity investing. Again, investors will need to be aware of market fluctuations and company-specific news. However, the right mutual fund can provide some insight into this process.
Using Commodity Pools To Invest In Commodities
Commodity pools are a way to combine resources from a group of investors to purchase futures contracts and options. The commodity pool operator (CPO) will distribute account statements and annual financial reports to the investors involved. The combined structure of a commodity pool will typically allow for larger investment opportunities to be made.
Each pool will typically employ an advisor who is required to register with the Commodity Futures Trading Commission (CFTC). Advisors are then able to provide investment advice on the various options. Similar to mutual funds, investors will often choose to work with commodity pools because of the added benefit of a financial advisor.
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What Are The Best Commodities To Invest In?
When choosing a commodity to invest in, there are two important factors to consider: supply and demand. While most commodities benefit from a consistent or global demand, some have performed better over time than others due to their limited supply. Beginner investors should consider these commodities as a great place to start:
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Crude Oil
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Gold
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Base Metals
Crude Oil
Crude oil has long been a popular commodity investment due to its many uses. Crude oil can be used not only for gasoline but also petroleum products — which include plastics, asphalt, fertilizer, solvents, ink, and even cosmetics. There are multiple ways to invest in oil, though some can require high amounts of capital to start in. Investors who are interested in crude oil investments can purchase stocks in oil companies, ETFs, and even mutual funds.
One of the biggest risks associated with crude oil is that its profitability is highly susceptible to changes in demand. As mentioned above, oil was one of the many investment types negatively impacted by the events of 2020. That being said, due to changing geopolitical events oil prices have risen dramatically in recent months. These fluctuations illustrate how quickly changes can occur in demand and prices.
Gold
Most people think of an investment in gold as the purchase of jewelry or old gold coins. In reality, there are numerous ways to purchase this commodity — each of which can be profitable when done right. Gold can be a highly attractive investment because of its performance against inflation. Typically, as the value of the U.S. dollar decreases, gold prices increase. This makes investing in gold a common route for investors looking to diversify their existing portfolios.
There are a few different ways to invest in gold including buying physical gold, futures contracts, or stocks in gold mining companies. Each of these investment types does come with its own set of risks and benefits, but as a whole can offer investors the opportunity to profit from this precious metal.
Base Metals
Base metals are a popular commodity to invest in because of their consistent global demand. These metals are known for their use in commercial and industrial industries and are commonly found all over the world. This makes base metals relatively inexpensive to invest in, while also still having the potential to yield high profits. Although, investors would have to purchase large amounts of the materials to see returns from the physical commodities. Because of this, the most beginner-friendly way to invest in base metals is often by purchasing stocks in mining companies.
What Are The Best Commodity Stocks & ETFs?
As you begin researching commodities stocks and ETFs you may be surprised by the sheer amount of options available. A good rule of thumb is to begin by researching a specific commodity — and then looking through each of the main players in the industry. When it comes to commodity stocks, these are the main companies to help you get started:
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Valero Energy: Gasoline, heating oil
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Tyson Foods: Cattle, pork
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Archer-Daniels-Midland: Corn, wheat, and other agricultural commodities
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Anglo-American Platinum: Base metals
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Barrick Gold: Gold
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Freeport-McMoRan: Copper, Gold, and energy products
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ExxonMobile: Crude Oil
Those interested in ETFs should follow a similar process. Begin by looking into the commodity type you are interested in and then research different funds. Some of the most commonly available ETFs are as follows:
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VanEck Vectors Gold Miners
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Teucrium Corn Fund
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Aberdeen Standard Physical Silver Shares
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United States Oil Fund
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iShares Silver Trust
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SPDR Gold Trust
Related: What Are Alternative Investments?
When Should You Invest In Commodities
The right time to invest in commodities is not always clear. As is the case with many investment types, a general rule of thumb is to buy when the price is low and outlook is good. Investors will need a good understanding of the market to predict these instances.
Inflation is another good indicator of the right time to buy commodities. Generally speaking, commodities can help investors protect against inflation. If it appears inflation is on the rise, it may be time to consider this strategy. However, inflation is not always easy to predict especially as markets continue to fluctuate from the impacts of COVID-19.
Are Commodities A Good Investment
Commodities can be a good investment for many portfolios. As mentioned above, commodities do not rely on the same market forces that impact other investments. Instead, many commodities are ruled by the principles of supply and demand. This removes some of the risk involved in investing in commodities.
Certain commodities are thought to be historically reliable investment options, such as gold. Many investors use gold to safeguard their portfolios especially during times of market instability. That being said, commodities are not immune to certain risks and investors should always weigh their decisions carefully.
Summary
Trading commodities is one of the oldest forms of investment types, dating back hundreds of years. Learning how to invest in commodities is a fairly simple process as well. Even today, they continue to offer a high-profit potential because of steady global demand. While commodities are not entirely immune to market fluctuations, they can still be a great opportunity for those looking to diversify. Investing in commodities can be done in several different ways, with options catering to various levels of experience and capital. What they all have in common is their ability to expand even the best investment portfolios.
Have you ever invested in a commodity type? Share your experience in the comments below.
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