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What if you could earn returns from investing in the products you use daily, like breakfast or toiletries?
From coffee beans that brew your morning cup of Java to wheat used in baking bread, palm oil in your soap, and copper wire that powers household appliances, these commodities offer an alternative for investors looking to diversify beyond traditional asset classes like stocks, bonds, and currencies.
Would you like to learn how to invest in commodities? Let’s explore all the factors you need to consider before diving into commodity investments.
Key Takeaways
- Understanding the specific factors that affect each individual commodity is important for ensuring successful commodity investments.
- Commodity prices are primarily driven by supply and demand dynamics, which are influenced by many factors.
- Traders frequently use supply and demand fundamentals to make speculative bets, which can increase market volatility.
- Staying informed about market conditions through research can help mitigate potential risks.
- External risks are increasingly unpredictable due to climate change and geopolitical tensions.
- Show Full Guide
What Are Commodities in Investing?
Commodities are natural resources from agriculture, energy, and mining that can be processed into goods for everyday use and traded in various markets, including futures and derivatives exchanges.
These natural resources can serve as investment assets. But are commodities a good investment in 2024, and how can you buy them?
Types of Commodities
Commodities traded in global physical and exchange markets for investment assets are typically key raw materials essential for various applications.
These include:
- staples like wheat, sugar, palm oil, soybean, and coffee
- infrastructure materials such as copper, nickel, and aluminum
- energy resources like coal, oil, and natural gas.
Based on types, commodities can be classified as follows:
Different Ways to Invest in Commodities: Physical Assets vs. Derivatives
Investing in commodities comes in different options that investors can choose based on their risk tolerance, investment goals and the amount of capital they have. Most of the instruments are also commonly used in trading traditional assets, such as bonds and stocks.
There are two main ways of commodity investments: direct and indirect investments.
- Direct investments include buying and selling commodities in physical forms or stocks of commodity companies.
- Conversely, indirect investments in commodities include buying and selling commodities exchange-traded funds (ETFs), contracts for difference (CFDs), and other alternative commodity investments.
So, where to trade commodities? Investors can purchase commodities in derivatives and stock exchanges.
Let’s view how to buy commodities and add them to your portfolio.
Physical Ownership
With the exception of precious metals, buying commodities physically is generally not feasible due to storage issues. For gold and silver, retail investors can still purchase them in the form of bars or coins as small as one gram. However, other commodities come in large quantities, making storage and delivery too expensive for individual retail investors.
For instance, one barrel of crude oil is roughly 159 liters, and one bushel of wheat weighs about 60 pounds, quantities that cannot simply be stored in a backyard.
The limited shelf life adds to the storage complexity. Most agricultural commodities, such as coffee beans, cocoa beans, wheat, and rice, are perishable goods with only a few years of shelf life before their quality deteriorates.
Consequently, only companies that need physical commodities for their operations or trading houses that deal with commodities for end users typically own physical commodities.
Futures Contracts
Investing through futures contracts is a preferred method of the direct purchase of commodities. A futures contract is an agreement between a buyer and a seller to buy or sell a commodity at a fixed price and specific amount on a future date, known as the expiration date. The futures contracts are traded at regulated commodities exchanges.
On the expiration date, the buyer must pay and receive the underlying commodity, while the seller must deliver it. However, most futures contracts now are settled in cash without physical delivery, sparing both parties the headache of handling large quantities of commodities like oil or soybeans. As a result, futures markets primarily serve as benchmark prices for commodity trading.
Investors can also roll over contracts to a later date to extend their exposure to commodity prices.
Two Types of Futures Contracts
There are two types of investors in futures contracts: commodity end users and speculative investors.
- End users trade futures to hedge against price volatility and manage costs or minimize losses. For example, an airline might buy a futures contract to lock in jet fuel prices, allowing it to stabilize fuel costs during price swings. Similarly, a grain trader might buy soybean or wheat futures contracts to ensure a stable selling price, anticipating a market downturn.
- Speculative investors, on the other hand, aim to profit from price movements. For example, a trader might agree to buy gold in three months at $2,600 per ounce. If the price rises to $2,700, they profit; if it falls below $2,600, they incur a loss.
The primary advantage of commodities investments using futures contracts is that investors don’t need to set aside large amounts of capital. Instead, they can trade on borrowed money. They only need to provide a small deposit or margin, with their broker providing a loan for the remainder of the full trade’s value.
To start investing in futures contracts, you can open a brokerage account and pay various fees, including contract, exchange, and regulatory fees and commission, which vary depending on the commodity being traded.
Best-Performing Commodities in 2024
Are you wondering what are the best commodities to invest in 2024? There are many investment platforms now that provide real-time commodities prices. So far, the top five commodities futures based on their one-year gains are as follows:
| Commodities | Current Price
(As of August 19) |
1 Year |
|---|---|---|
| US Cocoa Futures
(Intercontinental Exchange US Cocoa futures) |
$7,408.50/ton | +120.65% |
| London Coffee Futures
(Intercontinental Exchange EU Robusta Coffee Futures) |
$4,453/ton | +75.35% |
| US Coffee C Futures
(ICE Arabica Coffee Futures) |
242.15 US cents/lb | +65.43% |
| Orange Juice | 458.88 US cents/lb | +40.70% |
| Spot Gold (XAU/USD) | $2,540.75/oz | +32.16% |
Futures contracts can be extremely risky because commodity prices are inherently volatile compared to other traditional asset classes, such as stocks and bonds. Novice investors are advised against investing in futures contracts.
Futures Options
However, investors also have the alternative of investing in lower-risk futures options, which basically give investors the right, but not the obligation, to buy or sell the underlying asset at an agreed price, known as a strike price, before or on the expiry date.
Investors decide whether to exercise this right based on market conditions when the contract expires.
Therefore, if the futures price does not move in the expected direction, investors only lose the initial amount paid for the option.
Commodity Stocks
Investors can also gain indirect exposure to commodity prices by trading stocks of companies that produce certain commodities or commodity trading houses that trade various commodities. Both serve as opportunities for investments in commodities.
The share price of a commodity company typically follows the commodity price. When oil or gold prices increase, the share prices of oil companies and gold miners, or mining companies with gold production, tend to rise as well. This is because investors expect these companies to generate higher revenues and profits from selling the commodities at higher prices.
Another advantage of investing in commodity stocks is dividends, which are typically paid periodically, either annually or quarterly.
The pitfalls of investing in commodity stocks are that investors must track not only the commodity price movements but also the company’s overall performance and corporate actions, such as merger and acquisition plans, changes in management, events that disrupt commodity production, and other fundamentals.
Popular Commodity Stocks
Based on market capitalizations, some of the popular publicly-listed commodity companies or trading houses are as follows:
- Saudi Aramco is the biggest crude oil producer, with a market cap of $1.828 trillion as of August 2024.
- BHP Group is the world’s largest mining company with a $136.89 billion market cap. It produces a wide range of essential metals and energy commodities, including iron ore, copper, metallurgical coal, and nickel.
- The U.S. miner, Newmont Mining Corp. (NEM), is the world’s largest gold producer, with a $58.52 billion market cap as of August 2024.
- Singapore-headquartered Olam Group is another global agriculture produce trading house with market positions in grains and oilseeds, animal feed, edible oils, rice, and commodity financial services.
- The London-listed trading house, Glencore (GLEN), produces and markets metals, including nickel, copper, and iron ore, as well as energy commodities such as coal and crude oil.
Commodity ETFs
For investors who wish to invest in commodities without committing large amounts of capital, exchange-traded funds (ETFs) could be an option.
By buying ETF shares, investors can gain exposure to the underlying assets within the fund without having to buy each asset individually.
The funds provide various advantages, such as diversification of investment portfolios and cost-effectiveness. Compared to futures contracts, they generally involve lower risk and require less capital.
ETF commodities can include a single physical commodity stored in an exchange facility or physically backed by the underlying asset, a collection of commodity futures contracts, or a commodity index.
According to VettaFi’s database, some of the popular commodity ETFs include Invesco DB Agriculture Fund (DBA), Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC), United States Copper Index Fund (CPER), United States Oil Fund (USO), and SPDR Gold Shares (GLD).
Contract for Difference (CFD)
Another option for commodity investments is betting on whether a commodity’s price will go up or down without having to own it, using a financial derivative called a contract for difference (CFD).
A CFD is a contract between a trader or investor and a CFD provider, typically a brokerage firm. Trading a commodity with a CFD involves paying the difference in the asset’s price between the trade’s opening and closing.
How Does CFD Work?
An investor enters into a CFD contract with the expectation that the price of the commodity will increase, known as a long “buy” position. They will make a profit if the commodity price rises, and they can sell it at a higher price than the initial purchase price. Conversely, they will incur a loss if the price falls and they have to sell it at a lower price than the initial price.
On the flip side, investors can open a short “sell” position if they expect the price to fall. If the price drops as expected, they can make a profit by buying the asset back at a lower price than when they initially sold it. They will incur a loss if they have to buy back the asset at a higher price than the price at which they sold it.
In essence, profit or loss is determined by the difference in price between the start and end of the trade.
Alternative Investments
In addition to financial investments, there are other alternative commodity investments, although they may not be as popular and sometimes apply only to certain commodities.
A handful of commodities do not have futures or special exchanges, either because the volume is too small or due to the strategic nature of the commodity. Instead they are traded in the spot market using the current price or spot price. Examples of such commodities are lithium and uranium.
For investors interested in profiting from investing in gold and silver, buying jewelry can be an alternative. In fact, investing in gold and silver jewelry is common among retail investors in Asia. Silver coins or medallions sold by government mints are another option for investing in physical assets.
An MLP pools funds from investors to manage investment projects and operations. It has general partners who manage the business and limited partners who strictly invest the money.
According to the Gana Weinstein law firm, royalty trusts are financing vehicles run by banks and can be traded like stocks. Royalty trusts’ income derives from the actual production of natural resources such as coal, oil, and natural gas. Consequently, the cash flow will be affected by the fluctuation of commodity prices and production.
Where to Buy Commodities ETF, CFD & Other Assets?
You can buy various commodities investments by opening online brokerage accounts or visiting traditional brokerage firms. You can also open an account at investment banks, use online investment apps, or buy directly from fund providers.
Essential Factors to Consider Before Investing in Commodities
According to a rule of thumb in investing, the more volatile the asset, the higher the potential return. This applies to commodities as well. While commodities can offer profitable returns, they are among the most volatile asset classes.
This is mainly because price fluctuations are driven by a plethora of external factors, which are often beyond our control. These factors can range from supply and demand to inflation and environmental risks.
Before deciding to invest in commodities, it is advisable to understand the factors that can affect commodity prices.
Commodity prices are mainly driven by supply and demand fluctuations. An oversupply amid sluggish demand could potentially lead to a fall in the price of a commodity. On the other hand, a commodity price could spike when there is a sharp increase in demand amid a decrease in supply.
Supply disruptions can be caused by many factors, such as extreme weather, animal and plant diseases that reduce harvests, natural declines, and technical problems, such as fires at refineries or equipment glitches at liquefied natural gas (LNG) facilities and mining accidents.
Demand can wane or surge depending on shifts in consumption patterns, economic conditions, and the emergence of substitute commodities. The supply-demand influence is one reason why it is risky to invest in a commodity.
Commodities markets are typically more volatile than other markets because prices are often driven by speculative moves. When supply and demand are closely matched in commodities trading, traders will take a long position if they expect prices to rise or a short position if they anticipate prices will fall in the near future.
A recent example of market volatility occurred with the London Metal Exchange’s nickel futures in March 2022. Over the course of three days, the price of nickel surged by 270%, reaching an unprecedented price of $100,000 per ton. This spike was partly driven by Russia’s invasion of Ukraine in late February, as Russia is the world’s fourth-largest nickel producer.
Before the invasion, traders had taken short positions, betting that the price of nickel would fall. However, as the price started rising due to the war, these traders had to provide more capital to cover their losses by buying nickel. At the same time, there were few traders willing to sell nickel at lower prices, which pushed the price even higher.
Political events, such as elections, wars, and social unrest, can disrupt production and logistics, triggering a spike in price. Energy and mining facilities are often targeted in attacks during armed conflicts.
Farmlands or commodity production facilities may cease operations if workers refrain from coming to work due to safety concerns. The local community can block mine sites, plantations, or oil and gas field operations to voice their grievances.
Investors who wish to invest in commodities must follow key economic indicators, such as gross domestic product (GDP), the inflation rate, consumption, investment, and trade.
These indicators measure the health of a country or regional/global economy, which can affect commodity supply and demand and, subsequently, commodity prices. During an economic downturn, consumption may be sluggish as consumers tend to be more cautious with their spending. On the other hand, during an economic boom, consumers may spend more, including on big-ticket items such as cars.
Most commodities are priced in U.S. dollars. Therefore, fluctuations in the U.S. dollar can affect commodity prices in other currencies. When the U.S. dollar appreciates, commodities can become more expensive in other currencies, potentially dampening consumers’ purchase of commodities. Additionally, commodity companies might experience decreased revenue due to currency losses.
Conversely, when the U.S. dollar depreciates, commodities tend to be cheaper in other currencies, which can increase demand. Commodity companies might also benefit from increased revenue as a result of currency gains and may produce more to take advantage of the favorable exchange rates in other currencies.
Each commodity has its own cycle of production and demand. Many agricultural commodities, for example, have two harvest seasons or experience a period of seasonally low production.
For instance, natural rubber undergoes an annual period known as ‘rubber wintering,’ when rubber trees shed their leaves, reducing latex production. Seasonality can vary depending on factors such as climatic events.
Extreme weather and natural disasters can severely impact commodity supply, resulting in price volatility. In recent years, global warming has intensified the severity of rain, drought, storms, and floods. Erratic weather patterns have reduced yields in many agricultural commodities by worsening pest attacks or inhibiting plant growth.
Climate events such as floods and hurricanes can disrupt energy production, slow down or pause mining activities, and hamper shipments.
The accelerating drive to decarbonize the economy has boosted demand for technologies and materials associated with energy transition. As demand rises, especially when competing with traditional commodity consumers, it can lead to greater price volatility.
For instance, stainless steel producers are facing increased competition from electric vehicle (EV) battery makers. In agriculture, land that was previously used for growing food crops is increasingly being converted to grow fuel crops, such as palm oil or soybeans. This could potentially worsen the competition between energy and food.
Governments of commodity-producing or commodity-consuming countries can impose trade policies to either pursue resource nationalism or safeguard domestic markets. These policies can take the form of fiscal measures, such as import duties or outright export/import bans. Such policies can increase the risk of price volatility.
An example of fiscal policy in the commodity sector is India, the world’s largest edible oil importer, which regularly raises or lowers import duties on edible oils to ensure a sufficient supply of these staples at home without harming the interests of edible oil farmers, processors, and consumers.
Another example is Indonesia’s 2019 ban on unprocessed nickel ore exports, which was implemented to develop domestic smelters and to export higher-value nickel products.
On a global scale, the intergovernmental group known as the Organization of the Petroleum Exporting Countries (OPEC) regularly sets oil production policies to adjust to supply and demand dynamics. The goal of these policies is to achieve reasonable oil prices for both their members and consumers.
How to Start Investing in Commodities: Step-By-Step Guide
Regardless of the asset class in which you intend to invest, there are some general considerations you may take to ensure successful investments in commodities.
Let’s have a look at the following steps before investing in commodities.
Get to Know the Commodities: Conduct Your Research
Before deciding on your preferred way of investing in commodities, the first step is to learn more about the asset, including how it works, the fees, and the potential gains and losses.
Key areas to research:
- Market Trends: Each commodity has unique trends that reveal opportunities and risks.
- Industry Knowledge: Understanding production processes and key players offers valuable insights.
- Production Methods: Knowing how commodities are produced helps assess supply chain risks.
Ways to research:
- Industry Reports: Regular updates from organizations like the EIA, OPEC, and the World Gold Council.
- Bank Reports: In-depth analysis from banks like JP Morgan and research firms like Fitch Ratings.
- Government Data: Statistics on exports, imports, and consumption.
- Company Reports: Financial disclosures reveal company performance and risks.
- News & Expert Opinions: Insights from financial advisors and industry experts.
Learn More About Investing in Commodities
Education is equally important for all investors. Many major commodity exchanges, such as the London Metal Exchange (LME) and Chicago Mercantile Exchange (CME), have education portals to learn not just about trading rules at the respective exchanges but also fundamental knowledge about each commodity and guidelines on how you can invest in commodities.
Investment education helps to protect investors against fraud and strengthen regulatory compliance. It also empowers investors to make informed decisions and achieve their goals.
Choose Commodity Investment Vehicles That Suit You Best
When you have done your research, the next important step is choosing one or more investment vehicles that align with individual needs. There are guidelines to help investors pick the right investment vehicle.
- Investment Goals & Risk Tolerance: Determine your risk tolerance and investment goals. Are you conservative, seeking modest returns, or willing to take on higher risks for greater rewards?
- One Basket or Multiple Baskets: The advice of ‘don’t put your eggs in one basket’ also applies to commodities investment. Diversification is key when choosing investment vehicles.
- Fees & Expenses: Each investment instrument has its own fees and expenses, such as brokerage fees, trade/clearing fees, and interest margins. Check with exchanges or brokers to get detailed information about these costs to avoid unexpected expenses.
John LaForge, the head of Real Asset Strategy at Wells Fargo Investment Institute told Techopedia by email:
“The portfolio benefit that commodities are most often associated with is diversification. Commodity prices, historically speaking, have not behaved like stocks or bonds. This can be a plus for portfolios, as proper diversification can often lead to better risk-adjusted returns.”
He recommends that investing in funds that hold a broad basket of commodities is the best way to take advantage of long-term supercycles.
Set Your Investment Goals
Financial investments, including commodities, are just one of many ways for individuals to achieve financial goals whether to prepare college funds for children, pension funds to prepare for a comfortable retirement, or just purely build personal wealth.
“For commodities specifically, it’s important to understand how they can be used in the portfolio to achieve one’s goals, whether it be through capital appreciation or simply diversification,” LaForge of Wells Fargo explained.
Usually, people have multiple investing goals. Investors might consider breaking them down into individual goals with specific timing targets.
- Set Time-Bound Goals: Define your goals as short-term (within 12 months), medium-term (1-5 years), or long-term (beyond 5 years).
- Calculate Required Funds: Determine how much money you need to reach your goals.
- Determine Returns: Identify the returns needed to meet your goals. Brokerage or securities firms usually provide prospectuses with historical data on how an asset has performed over one year, three years, five years, and longer.
Monitoring & Managing Your Investments
You may need to rebalance your investment portfolio over time because the price or value of assets may fluctuate.
Specifically for commodities investments, Wells Fargo’s LaForge added that investors must understand commodity supercycles because they have often been the driving force behind performance in the past.
“Therefore, it’s important to monitor one’s investment performance and rebalance portfolios accordingly—understanding where the supercycle stands—to keep long-term investment goals on target,” he said, adding that the commodities markets are currently in the fourth year of a bull supercycle that began in March 2020.
Risks of Investing in Commodities
Investing in commodities, just like in any asset has its risks as follows:
- High Volatility
Commodity prices are notoriously volatile compared to other assets, such as bonds, stocks, or currencies. This is because commodity prices are predominantly affected by events that are beyond our control, such as natural disasters, political risks, extreme weather, economic conditions, and regulatory risks. - Lacking Regular Income
Unlike bonds or stocks that provide regular income from yields or property from rental fees, investing in commodities does not generate regular income. Profits are solely generated from the price fluctuation of the commodities. An exception is investing in stocks of commodities companies, as shareholders receive income from dividends in addition to share price movement. - Speculative Risks
Investors frequently make speculative bets based on supply and demand fundamentals. This often results in price spikes, which can have a negative influence on markets and the broader economy. Spikes occur when there is an abrupt change in supply or demand conditions, as well as investor outlook. As a result, it could drive up price volatility and uncertainty.
Main Benefits of Commodities Investments
Are commodities a good investment? There are advantages of commodities that continue to attract investors despite their known risks.
The benefits of investing in commodities are as follows:
- Hedge Against Inflation
Commodity prices typically move in line with inflation and often indicate inflationary pressure. As a result, commodities can offset losses that inflation may bring to other assets. - Diversification
Commodities offer investors a wide range of individual commodity assets, and their price movements are generally not correlated with traditional assets such as bonds and stocks. This allows investors to spread risk across different asset classes. - Potential for Large, Short-Term Returns
Commodities that are sensitive to changes in economic conditions and business environment or other external events, such as oil, gold, most base metals and wheat, can experience large price swings that offer opportunities to generate significant returns. While commodities can’t provide long-term and regular returns, investors can profit quickly by correctly predicting price directions at the right time. - Managing Costs
For end-users whose expenses are greatly influenced by commodity prices, investing in commodities can help manage costs by locking in prices using futures contracts. As a result, they can keep fuel or raw material costs down during price increases. However, they may incur losses when prices decrease.
The Bottom Line: Should I Invest in Commodities?
Investing in commodities allows investors to diversify their investment portfolios, manage risks, generate significant potential returns, and assist end users in keeping expenses under control.
However, there are risks linked with unforeseen events that can abruptly increase price volatility. Investors will need to conduct extensive research before deciding to pursue investments in commodities. It is recommended that you consult with financial consultants, to help you develop investing strategies and select appropriate investment vehicles.
The information in this guide does not constitute investment advice and is meant for informational purposes only.
Do your own research and always remember your investment decision depends on your attitude to risk, your expertise in the commodity market, the spread of your portfolio, and how comfortable you feel about losing money.
FAQs
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References
- Commodities Futures Prices – Investing.com (Investing)
- Saudi Aramco (2222.SR) – Market capitalization (Companiesmarketcap)
- Largest mining companies by market cap (Companiesmarketcap)
- Largest gold mining companies by Market Cap (Companiesmarketcap)
- About Us (Olamgroup)
- Metals & Minerals (Glencore)
- ETF Database Categories | ETF Database (Etfdb)
- Oil and Gas Royalty Trusts :: Investment Fraud Attorney Gana Weinstein LLP (Ganalawfirm)
- Welcome to Department of Food and Public Distribution (Dfpd.gov)
