How To Invest In Commodities: 5 Simple Strategies was written for Playlouder by a contributing author. Please note that contributing opinions are that of the author. They are not always in strict alignment with my own opinions. –Joe
Prospective traders had far fewer options to invest in commodities before online trading took the stage. Today, you can speculate on commodity price movements with or without actually owning the asset.
Before we explore how to invest in commodities, you need to understand the following factors that determine which method you choose:
- Decide what commodity you want to trade. Keep in mind that some commodities are only available via selected medium — like futures or outright ownership.
- If you want to trade a commodity without ownership, you’ll need to choose a type of investment that speculates on asset prices through a contract.
- Some ways to trade, like bullion, often come with management and security costs.
- If you want to speculate on a commodity’s price at a particular future date, you’ll need to invest in a contract with an expiry date.
- Trading with leverage allows you to invest in larger volumes than your actual cash balance. If you can take this risk, look for leveraged ways to trade your chosen commodity, but remember that betting more than your balance can also mean that losses could incur more debt than you own.
Next, we explore different ways you can start investing in commodities.
1 – Buy Precious Metals Through Bullion Dealers
Most countries have bullion dealers, both brick-and-mortar and online shops. They allow you to buy or sell metals like gold, silver, platinum, and palladium. Some offer other commodities as bullion, too, like copper and rhodium.
Common bullion forms include coins and bars, also called ingots. Prices are defined by current metal values and the rarity of the bullion item. This means that a bullion coin’s face value may be significantly less than its market value.
When you invest in commodities via bullion, namely metals, you may be subject to management costs:
- For example, if you buy 10 x 10 oz gold bars, you have 100 ounces of gold on your hands. The bullion dealer may have secure storage facilities to store your assets, for which they will charge you.
- If you choose to have 100 ounces of gold delivered, the company may charge you for secure door-to-door transport.
- For those who arrange private storage for such quantities, there are further additional costs.
Unlike derivatives, you own the bullion you purchase and with that comes more financial responsibility as well as storage considerations.
2 – Buy Stocks or ETFs
Perhaps the most indirect way to trade commodities is through company stocks. For example, there are dozens of mining companies that specialize in industrial metals. By investing in these companies, you’re investing in the commodities they sell or produce.
As the largest mining company in the world, Glencore produces copper, cobalt, zinc, and nickel. It also markets iron ore and aluminum from third party producers.
For example, a trader wants to invest in copper, zinc, and nickel, without directly owning any of these metals in bulk. They may purchase Glencore stock at $400 per share, a total of 100 shares worth $40,000.
If Glencore performs as a result of an upward economy around these metals, the trader will profit without having touched the asset.
Another way to speculate on commodities is via exchange-traded funds (ETFs) – pooled investment securities, some which track the price of a particular commodity.
For example, a trader wants to invest in agricultural commodities through ETFs. They purchase Teucrium Corn Fund, Teucrium Wheat Fund, and Teucrium Soybean Fund. These ETFs give the trader indirect exposure to corn, wheat, and soybean prices.
3 – Mutual Funds
A mutual fund consists of a brokerage combining investments from multiple sources to allocate to a particular group of assets. Much like we just discussed with ETFs, mutual fund prices are determined by multiple investment products, whether they’re indices, stocks, or other complex financial instruments.
Investors tend to trust mutual funds due to their successful history and risk-tolerant practices. Popular mutual funds in the energy commodity sector include:
- Fidelity Natural Resources Fund (FNARX)
- Fidelity Select Energy Portfolio (FSENX)
- Vanguard Energy Fund (VGENX)
- BlackRock Energy Opportunities Fund (BACAX)
Such funds trade on exchanges and are also accessible through derivatives like futures, options, and CFDs with selected brokers.
Each mutual fund clearly discloses necessary investor-facing information, like the total value of assets under management, annual returns, and the current expense ratio.
4 – Invest in Futures & Options Contracts
The majority of popular commodities are accessible on national and international exchanges. Typically, futures contracts are available precious metals, common metals, soft agricultural commodities, and energy commodities.
Some exchanges specialize in a single category, like the London Metal Exchange (LME). Others like the Chicago Mercantile Exchange (CME) offer commodity groups, along with futures and options on products like equity indices, forex, interest rates, and more.
Futures and options contracts are considered derivatives and allow you to transact at a set future date. However, a futures contract obliges two parties to exchange a commodity, while an options contract gives the buyer the right, but not the obligation, to purchase a commodity until a set expiry date.
Both options and futures contracts incur additional costs when deliveries are fulfilled.
For example, a trader sees potential in corn prices to increase from $650 to $700 within the next 4 weeks. The buyer pays a $100 premium for a $670 call option (right-to-buy), which gives him the right to purchase on the expiration date at $670, irrespective of corn’s price on the day.
The buyer can wait and buy, or re-sell the contract to another trader, depending on what he deems a better choice.
5 – Contracts for Difference (CFDs)
Contracts for difference (CFDs) are another form of derivatives. You do not own the underlying instrument, nor the contract.
A CFD is an agreement between you and a third party, typically a broker, where the buyer or seller pays the difference between the contract opening and closing price to the opposing party.
Traders often bet on CFDs with huge margins, and it’s considered one of the highest risk ways to trade commodities. You can trade ETFs, stocks, commodity indices, and individual commodities through CFDs.
For example, a trader buys 100 share CFDs of a silver company stock at $22.45 per share on a 30% margin requirement. The trade costs $2245, plus any additional costs like commission and spreads. In turn, the trader must have 30% of the total value ($2245) in cash balance, which is $673.50 to open the trade.
CFDs are risky when traded on a margin, since a trader’s cash balance can hit zero with very little share price movement. The same is true for CFDs traded on ETFs, mutual funds, or directly on commodities like live cattle, lumber, and so on.
It can seem intimidating to start investing in commodities, but as long as you’re willing to lose the money you invest, you can try different types of derivatives — whether for coffee, cattle, or copper.