How To Invest in Commodities: A Complete & Free Guide 2023
Investing in commodities is a crucial element to many individual investors’ portfolios, though the commodity market can often be overlooked.
With roots dating back to farmers who would take their agricultural goods to the market to sell to consumers, the commodity market is now a highly modernized and sophisticated aspect of the global financial markets.
There are a number of reasons why you would invest in commodities, and there are a few key ways that you can do so, which we will discuss throughout this guide.
What Is Investing In Commodities?
First, let’s cover what it means to invest in commodities or the raw materials that are used as inputs for food, consumer goods, or other products.
Trading commodities can be done in a number of ways, like actually purchasing the physical commodity, purchasing commodity exchange-traded funds (ETFs) or commodity funds like mutual funds that track specific indexes, or buying commodity stocks of commodity-producing companies, like oil companies or gas producers.
Another common way to invest in commodities is through futures contracts. This means the investor is agreeing to buy or sell the commodity at a given price and date in the future. Commodities futures and futures trading in general is a way to speculate on commodity price movements, though there are risks involved with the futures markets.
Either way, if you decide to invest in commodities, it’s important to know that it’s a volatile market, and commodity prices of the underlying asset can change rapidly. So, it’s best to understand the risks present in this investment strategy before investing in commodity futures, commodity ETFs, commodity companies, or other commodity investments.
Read More: Best Commodity Brokers 2023
Types of Commodities
Now that you know how trading commodities works, let’s cover some of the main types of commodities that exist. Today, the commodity market has expanded beyond physical agricultural goods to include raw materials, precious metals, and many others.
First, the two many types of commodities are hard commodities and soft commodities. Hard commodities are typically natural resources that are mined from the earth, like gold, oil, or other precious metals. On the other hand, soft commodities refer to agricultural products or livestock, like coffee, soybeans, pork, wheat, and corn.
As an asset class, commodities are pretty broad and versatile, ranging from physical raw commodities to even things like cellular data units. So, it will be no surprise as new commodities are added to the mix in the future based on how technology expands and the world itself changes.
Commodity Investing: Advantages & Risk
After learning a little more about the specific commodity options that are out there, let’s go over some of the main benefits and drawbacks of investing in commodities through a commodity ETF, commodity index fund, commodities stocks, and more.
Commodity Prices: Protection Against Inflation
The first benefit we’ll cover is that investing in commodities gives you a good hedge against high inflation. Commodities like crude oil are used as an input for the manufacturing and operation of many things within our global economy, making it a good inflation hedge.
So, as prices for goods and services go up, this generally means that the prices for physical commodities like crude oil will also be on the rise. Thus, learning to trade commodities during inflationary periods rather than other assets can be a good way to protect the value of your investment portfolio, even while other areas of the economy like the equity markets are faltering.
Correlation To Other Assets Is Low
Similarly, commodities’ performance has a low correlation with other asset classes like the stock market. Therefore, commodities investors can gain a lot by commodity trading rather than solely purchasing stocks. Overall, this helps sophisticated investors diversify their portfolios and hedge against downturns in the stock exchanges or other areas of the financial system.
Thus, many investors can gain a lot by investing in commodity mutual funds if they’re also invested in equity mutual funds.
Risk in Commodity Investing
Lastly, there is a general risk that comes when you trade commodities. So just as having commodity exposure in your portfolio can benefit you, you should also be aware of the volatility of the commodity markets, and how quick price movements could prove detrimental to you. This is especially true when you’re leveraged and purchasing a commodity futures contract.
Even though commodities can be a good addition to your portfolio, you need to make sure you’re still making smart investing decisions and not overleveraging yourself. Just as the market price of a commodity rises, it can fall just as quickly and wreak havoc on your portfolio if you’re not well-balanced.
How To Invest In Commodities In 2023?
We can now go over some clear ways that you can do commodities trading in today’s market.
Buying futures contracts is one way to invest in commodities. As we mentioned above, this means that an investor agrees to purchase or sell a commodity at a future date and price. Investing in a futures contract is a good way to speculate on the price movements of the underlying commodity, though futures contracts can also be one of the riskier ways to invest in commodities.
Physical Ownership of Commodities
Aside from purchasing futures contracts, you can also invest in commodities through commodity trading of the particular commodity. This means that you will purchase the commodity and actually take physical ownership of it. This is more common with commodities like gold or other precious metals and isn’t as common nowadays as it was in the past.
You can also invest in commodity stocks of related companies to take advantage of the commodity markets. If you want to speculate on oil prices, you can purchase stock in a crude oil or gas producer or related mutual funds, not in the commodity itself. This is a more indirect way of participating in the market, though you also get exposure to the equity markets with this route.
Commodity Exchange-Traded Funds
Lastly, you can invest in commodities by purchasing shares of commodities ETFs. This is a fund that tracks the market price and performance of a given commodity and is easy to trade on major exchanges like a stock. So, some investors may like the convenience of purchasing an ETF as opposed to investing in futures contracts or physical commodities.
Commodities Trading vs Forex Trading
Investors may be curious about how commodities and forex trading differ from one another. While they may seem similar, there are some key differences between the two that make them unique from one another.
In the forex market, you are speculating on the price movements of foreign currencies, usually through the trade of currency pairs.
This differs from commodity investing, which you’ve seen throughout this guide involves investing in certain commodities to speculate on their price movements and take advantage of their low correlation to other assets.
However, some of the similarities are that they are both frequently traded through the futures markets to speculate on future price movements. So, many of the strategies and approaches to trading each of these assets can be quite similar, though you may choose to invest in one over the other based on your particular comfortability with one of the markets, your past experience, or available tools.
Read More: Best Futures Trading Platforms 2023
The Top 3 Commodities To Invest In
|Award||Best Protector Against Rising Prices||Best Industrial and Construction Indicator||Best Store of Value|
Invest in Energy
The most common commodity that is invested in is crude oil, which is a type of energy commodity. Oil is so widely used across our economy, spanning different industries, regions, and more. From fueling manufacturing plants that create consumer goods to fueling airplanes that transport passengers and goods all over the world, oil touches basically every part of human life at this point.
So, oil prices tend to perform well during expansionary periods, and given the fact that oil is still required for everyday life even in a downturn, it can still be a good investment during recessions as well.
Invest in Metals
Commodity trading of metals is a good way to take part in commodity industries that rely on metals as input parts, such as construction and other industrial uses. In general, during times of economic expansion and growth, the global demand for metals for increased construction activity will grow, meaning these commodity prices will also rise.
They aren’t as poised for recessionary periods as other commodities, though if you are investing in precious metals like silver or gold, this can still be a good option even as the overall economy falters, which we will dive into a little more info below.
Invest in Gold
Many view gold as a good physical commodity to invest in because it’s a good store of value, and gold prices generally perform well during times of overall economic uncertainty. Compared to other precious metals, it also tends to have a higher value, which is why many will choose to invest in gold bullion over silver and other metals.
Unlike other metals or commodities, gold doesn’t necessarily get used as an input to create other goods, giving it a unique value that is based on the item alone, not on the potential for creating other goods and products that can be sold.
Investing in commodities is a good way to diversify your holdings and take advantage of a whole different part of the financial markets that is largely uncorrelated to other segments of the industry. Investors like investing in commodities for the price speculation it provides, in addition to hedging against rising inflation and other traditional asset classes.
As you have seen throughout this guide, there are a number of ways to do commodity trading, and there is also a growing variety of commodities in general. No longer do commodities refer to staples like crude oil, natural gas, or gold, though these are still major players in the industry.
Frequently Asked Questions (FAQs)
This is an independent agency of the US government that regulates and oversees the US derivatives market. It has been around since 1974 and helps to make the markets fair for consumers.
A commodity pool is another way you can invest in this asset class and is actually a legal term itself. It is a type of private investment where investor funds are pooled together, then used to trade futures and commodities. This gives individual investors more leverage in trading, and the goal is to try to maximize the potential profits for the whole group.
While prices fall for other assets during inflationary periods, commodities generally benefit during this time as the price of these inputs rises as well. This is commonly seen in rising oil prices as overall inflation and rising interest rates take hold.
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