As commodity prices rise, this asset class, an alternative to traditional stocks and bonds, is catching the attention of investors.
Goods are raw materials that are either consumed or used to create other products. From orange juice to cotton, oil and gas to gold, goods come in many different forms.
As the US economy recovers from the isolation caused by the pandemic and spending soars across the board, the demand for commodities is on the rise. “This is a big shift from last year, when commodity prices fell and oil prices were negative,” said William De Weilder, chief economist at BNP Paribas Group.
Some commodities, such as gold, may reflect growing concerns about inflation as the economy is awash with fiscal and monetary stimulus. Other commodities such as copper are seeing a structural shift in demand as the metal is used in products like electric vehicles and other infrastructure built to combat climate change, De Weilder said.
If you are interested in investing in this space, here are some general questions that are likely to arise:
- How do you invest in commodities?
- What Should Investors Know About Commodity Trading?
- Why is it risky to invest in a product?
- Is investing in this type of asset right for you?
- How do you distribute the items in your portfolio?
How to Invest in Commodities
“There are several ways to invest in commodities,” says Will Rind, CEO of GraniteShares, an issuer of exchange-traded funds. Investors should consider the following options.
Buy stocks and bonds of commodity producers. A practical way to invest in commodities is to buy stocks and corporate bonds of commodity producers. Many of them are members of the S&P 500, such as the oil giant Exxon Mobil Corp. (ticker: XOM) and agricultural producer Archer-Daniels-Midland Co. (ADM). Other large commodity companies are not US firms. The BHP Group (BHP), headquartered in Melbourne, Australia, operates in over a dozen countries and produces a variety of commodities, from oil and gas to coal, copper and iron ore – one example of a commodity stock that spans the entire globe. Another example is Barrick Gold Corp. (GOLD), a Toronto-based mining company with an international interest in gold and copper mining.
Buy a commodity ETF. Range notes that there are several types of commodity ETFs. Some of them are indices of commodity producers, for example, VanEck Gold Miners Equity ETF (GDX), and some invest in commodities, for example, GraniteShares Gold Trust (BAR) and iShares Silver Trust (SLV).
Some commodity ETFs invest in commodity futures – a futures contract is an agreement to buy or sell a specific commodity at a predetermined price at a specific time in the future. The IShares S&P GSCI Commodity-Indexed Trust (GSG) tracks the S&P GSCI, a former Goldman Sachs commodity index that includes several commodity futures markets.
Buy physical goods. The easiest way for investors to access physical commodities is to buy precious metals such as gold, silver, platinum and palladium. They are available in the form of coins and bars from dealers in precious metals. To find a reliable dealer, check to see if they are a member of metal industry groups such as the Industrial Assets Council or the Professional Numismatists Guild.
Commodities can be inflation hedge. The current shortage of supply and demand for many commodities, from semiconductor chips to beef, is causing many to worry about inflation. Tom Essay, editor of the Sevens Report newsletter, talks about the major asset classes – stocks, bonds and commodities – commodities are most strongly linked to inflation, and commodity ETFs trade well during periods of rising inflation.
Video: Are Real Estate Investment Trusts a Good Investment? (Money Negotiation News)
Click to Expand
He says investors interested in commodities as a hedge against inflation might look to ETFs like the First Trust Group Tactical Commodity Strategy Fund (FTGC), which has about $ 1.5 billion in assets under management and balanced risks of agriculture, energy and metals. In addition, investors receive a Form 1099 when paying taxes. Some commodity ETFs issue K-1 Forms, which may require additional work when filing a tax return.
What you need to know about commodity trading
Commodity trading takes place on futures exchanges such as the CME Group or the Intercontinental Exchange, commonly known as ICE. According to Rynd, futures trading is usually the domain of professional traders because it is a derivative. The value of a derivative depends on the value of the underlying asset such as crude oil or wheat.
Futures trading on margin, which is the collateral that a trader provides when trading futures contracts, and is a percentage of the price of a security. There is an initial margin to open a position and a maintenance margin to keep the account active. Commodity futures trading can be very volatile and traders can lose more than their principal, especially if prices fall significantly as exchanges will make margin calls, requiring traders to invest more money to make the account whole.
In addition, futures contracts have expiration dates, and traders must control the scrolling of contracts, that is, move a position from an expiring contract to a new one, Reind says. If the trader allows the expiration of the contract, he must take delivery. Sometimes contracts are settled in cash, which means that the trader receives the monetary value of the contract, but some are physical delivery, which means that the trader receives the actual goods of the underlying asset. “It could be gold or live cattle,” he says.
Risks of investing in a product
Investing in the commodity market carries risks different from the risks of the stock market or the bond market because many variables affect the pricing of commodities. The factors affecting the orange juice market are very different from those affecting soybeans or lead. For example, weather plays an important role in agricultural markets and has little effect on energy and metals, Reind says.
In this space, prices are extremely volatile. Within a short time, commodity prices can plummet and peak.
Since many commodities are international in nature, investment returns are also affected by changes in exchange rates between foreign currencies and the US dollar. Since this is a global market, Rynd said there is potential for interventions such as OPEC oil pricing.
Is it worth investing in commodities?
This type of investment is risky and highly volatile. The lack of correlation between commodities and typical stock and bond investments can be beneficial at certain times, although commodity returns can reduce an investor’s overall return at other times.
Commodity investments are cyclical and vary, so commodities offer different returns. Over the past 10 years, the S&P GSCI price peaked in 2012, around 713, and bottomed in April 2020 at 230, mainly due to low oil prices. It is currently trading around 530 pieces.
Selected commodities also follow their ups and downs in price.
|TYPE OF GOODS||ACTIVITIES (2019)||
The above data from US Global Investors shows the range of returns for individual commodities. Note that crude oil was up nearly 35% in 2019 but fell more than 20% in 2020. Palladium is up about 54% in 2019 and nearly 26% in 2020. Corn is up 3.4% in 2019 but is up 24.82% in 2020. are the norm among individual products.
Financial advisors have different opinions about investing in commodities. When considering the goods as a whole, clear differences in the characteristics of individual goods are overlooked. For example, in 2020, when the S&P 500 rose nearly 18% including dividends, wheat rose 14.63%, copper 26.02% and silver 47.89%, according to US Global Investors.
Many advisors recommend a small share of commodity trading to offset volatility in stocks and bonds. 5% share in the stock of various goods – reasonable allocation.
The selection of specific commodity investments, such as wheat or oil futures bets, is quite speculative and is best left to professionals. Self-employed investors are best placed to invest in consumer funds if they do not have specific knowledge of a particular product.
Copyright 2021 US News & World Report