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A Comprehensive Guide on Commodity Investment

Commodity Investment

Are you looking for the best investment commodities? You’re in luck! In this blog, we have provided an in-depth guide on how to invest in commodities with a list of the best available commodities. 

Commodity trading has seen a massive surge in the past few years. More and more people gravitate towards reliable investment opportunities like commodities and stocks. In fact, commodities investment funds are one of the best short-term investment options besides equities and currencies. 

Investment in commodities can do wonders for a beginner portfolio. It can provide diversification to your portfolio and even provide an inflation hedge. However, trading commodities requires knowledge and skill as they are often highly volatile. 

Commodities are priced according to the market demand and the requirement for further processing. Moreover, factors like weather and political conflicts that are hard to predict also affect the prices of commodities. However, fret not. Keep reading to learn how to start commodity trading and the various types of investment commodities. 

What is Commodity Trading?

Before understanding how to start commodity trading, we must understand what commodities are. Commodities are natural resources or agricultural products that are grown, mined, or processed. Basically, any raw material or physical resource used in the manufacturing of processed goods is known as commodities. Any item that can be traded or moved is also defined as a commodity.

Primarily, there are two different types of investment commodities- 

Soft Commodity: Commodities that are grown and reared such as livestock and meat. Agricultural commodities like soybean, coffee, wheat, cotton, and corn also fall under soft commodities.

Hard Commodity: Commodities that are mined or extracted such as crude oil, coal, and natural gas. Industrial and valuable metals like gold, platinum, palladium, silver, copper, aluminum, and lithium also fall under hard investment commodities. 

Commodities of the same quality are also described as ‘fungible’. This means they are interchangeable whether they were farmed or mined.

Commodity trading is the process of buying or selling in bulk on spot markets or stock exchanges. Some of the largest exchanges include London Metal Exchange(LME), Chicago Mercantile Exchange(CME), the New York Mercantile Exchange(NYMEX), and the Intercontinental Exchange(ICE) in Europe.  

While physical commodities are traded and settled instantly, it is more common to trade in futures or contracts. A future allows buyers and producers to agree to a common price and delivery terms for a future date. The pricing is determined by supply and demand. 

If a transportation company thinks the prices of fuel are going to rise, they might lighten the risk by buying a futures contract in oil. This process is known as hedging. It helps the buyer and seller to lock in their prices and prevent any losses if the prices fluctuate. 

How to Invest in Commodities?

While learning the basics of commodity trading, it is also important to learn the various methods of investing in commodities.

Investing in Physical Commodities

Physical ownership of commodities is one of the most popular ways of investing. This is more of a traditional approach to investing in high-value commodities. It mainly applies to precious metals. For example- you can buy gold and silver from your nearest jewelry stores. Investors can purchase these metals in the form of bullion. Bullion bars have the closest value to the elt price(the market price for melted metal). 

However, owning precious metals in physical form comes with various challenges such as storage, liquidity, and insurance. Moreover, commodities besides precious metals have further storage issues as they are often in large quantities and come with a shelf-life. This means you must sell stocks within a given timeframe. That is why it is essential to have a storage facility and a reliable dealer to trade in physical commodities. 

Futures Contracts

Futures contracts are financial agreements where the buyer must buy a particular commodity at a specific price on a specific date to the buyer. The price of commodities cannot be altered in case of any price fluctuation as these are standard contracts for all. An investor also requires a brokerage account for future trading. Investors use margin accounts to take large portions of commodities with their capital. Often, future contracts are cash settled. The profits are based on future price fluctuation of the commodity. It is currently the most popular method of commodity investment. 

Invest in Commodity Shares

Another popular method to invest directly in commodities is to buy stocks in companies that produce, mine, or process commodities. Higher commodity prices with low production costs lead to increased profitability. However, there are many factors that can influence commodity stock prices including environmental issues, company-specific factors, and geopolitical issues. 

For example- if you invest in the stocks of a gold company, the stock price will follow the price of gold, allowing you to take an indirect approach while minimizing the risks. 

Commodity ETFs, and ETCs

Another popular and low-cost way of investing in commodities is Exchange-traded funds(ETFs), and Exchange-traded commodities(ETCs). While ETFs track the performance of an index or basket of commodities, ETCs track the prices of commodities. As ETFs and ETCs are traded on the stock market, you can purchase and sell them live like stocks. 

There are primarily two types of Exchange-traded Funds- 

Commodity ETFs: Holding the commodity in physical form or creating a portfolio of future contracts. 

Commodity-index ETFs: Track the price of a commodity index such as gas and coal, or track a bigger index like agricultural products or precious metals. 

Investing in ETFs is an affordable way of tracking a commodity index or a particular commodity, charging an annual fee of 0.2%, instead of 0.8% to 1% for actively-managed funds. 

Individual Securities

Investors require a brokerage account to access individual securities related to the production or processing of a commodity. Use a stock screener and look for materials or energy sector companies. However, investors looking for commodities through company stocks typically require extensive industry knowledge to trade successfully without losses. 

For example- Mining and energy companies have well-established feasibility studies on their reserves, which in turn influences the stock value. Larger enterprises have reserves in various parts of the world, which means that one single feasibility study doesn’t affect the stock value significantly. However, smaller companies may experience higher volatility based on a single feasibility study. 

Pros and Cons of Commodity Investment

Much like any other form of investment, commodity investment also comes with its fair share of pros and cons. 

Pros of Commodity Investment

Inflation Hedge

It is a well-known fact that the prices of commodities increase with inflation. Moreover, commodity prices are even monitored as indicators of inflation. While there are commodity-specific conditions that counter inflation, typically, commodities move with inflation and can balance out the effect that inflation may have on other assets in an investor’s portfolio. 

Portfolio Diversity

Commodity investment provides a distinct diversity in your portfolio due to a low correlation with financial assets. As mentioned above, commodities are majorly influenced by basic factors like supply and demand instead of central bank policies or employment numbers. 

Potential for High ROI

Commodity investment offers a huge opportunity for profits. Commodities like oil, gold, ad soft commodities with continuous production can experience large price fluctuations. Commodities are generally sensitive to global events and forecasts that impact the supply chain. This is what drives investors towards commodity investment. 

Cons of Commodity Investment

High Volatility

Commodities are highly volatile and can have their market prices fluctuate wildly based on global events. For example- wheat prices increased in 2022 due to the Russia-Ukraine conflict. As Russia is one of the biggest suppliers, similar impacts were recorded in the oil and gas markets. 

Lack of Income

Commodity investment generally doesn’t yield income like a dividend-paying stock or a bond. The returns on commodity investment largely depend on correctly predicting price fluctuations. 

External Risks

In commodity investment, there are plenty of external risks that the investor has no control over. Besides regional conflicts and political disputes, weather and climate also pose a major risk that can affect the flow of goods and the supply chain. All of these risks are also the primary reason for high volatility and higher returns. 

Now that you are familiar with the pros and cons of commodity investment, let’s take a look at the various strategies for trading commodities. 

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Useful Strategies for Commodity Investment

As with any other investment opportunity, it is essential to formulate a fool-proof strategy on how to invest in commodities. Different investors rely on different strategies as there is no surefire success mantra in trading. Here are some helpful tips to help you create a reliable commodity trading strategy. 

Learning & Research

First and foremost, it is essential to understand and gain insights into commodity investment before you can move forward. It will be in your best interest to learn how traders work and basic concepts like features, resistance levels, margins, etc. 

Technical Analysis

Each commodity features different technical attributes like volume, open interest, and chart patterns. An investor or trader must be familiar with what they depict to be able to make profits from a trade. 

Commodity Frequencies

Commodity Frequencies are another important aspect of commodity investment. While some commodities are traded seasonally, others are traded throughout the entire year. For example- gold and silver bullion are traded throughout the year, while seasonal crops like corn are traded during the harvest season. 

Portfolio Diversification

As a trader, it is important to diversify your portfolio to recover your losses from underperforming assets. One of the major rules of investment is to never invest all your funds into a single asset. Make sure to diversify your investments so you can recover even if one investment incurs a loss. 

Discipline and Consistency

Lastly, every investment requires discipline and consistency. It is essential for an investor to stay disciplined and consistent while trading. An investor must be resilient enough to face the downfalls of the market and learn from their past mistakes. 

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Best Commodities to Invest in 2023

Commodities were a reliable investment opportunity in 2021 and 2022. We have listed the top three commodities in the past four years based on the highest annual returns. 

2019202020212022
Palladium (54%)Silver (48%)Lithium (443%)Lithium (72%)
Crude Oil (34%)Copper (26%)Coal (161%)Nickel (43%)
Nickel (32%)Palladium (26%)Crude Oil (55%)Gas (20%)

As you can see, there are various types of investment commodities in the top three. While precious metals dominated in 2020, energy products and industrial metals dominated in 2021 and 2022 respectively. 

Now, let’s take a look at the top 5 commodities to invest in 2023

Oil

Oil is one of the most essential global commodities, serving as a key component in the manufacturing process and the primary energy source in transportation. In fact, fluctuations in the prices of crude oil can cause ripples through economies. 

For an experienced investor, oil can be an asset, a portfolio diversifier, and a hedge against inflation. However, it is important to note that oil is known for its volatility. Investing in oil requires considering the potential market risks, strategies for risk management, and an in-depth understanding of the factors that impact the overall price. 

Palladium

Palladium is a silver-like metal that is 30 times more valuable than gold and is used in various manufacturing processes. The majority of Palladium’s global supply is mined from the United States, Russia, South Africa, and Canada. 

It is considered a profitable commodity in 2023 as it is widely used in catalytic converters that transform around 90% of toxic gases from exhausts to non-toxic substances. As such, the automotive industry has a high demand for Palladium. High demand and low availability contribute to its rising rates and market worth.

Corn

Corn is a cereal grain cultivated and harvested worldwide. It is a vital food source in many countries, even exceeding production amounts of other largely used crops like wheat and rice. This is due to the fact that corn is used in various products like popcorn, masa, polenta, cereal, and corn-starch by-products like corn syrup and corn flour) 

It is also used to feed livestock and is also used to produce corn ethanol. Moreover, it is also used to produce a wide range of industrial products like plastic and adhesives. 

Cotton

Cotton is primarily cultivated for its fiber in tropical and subtropical regions of the world. Its fiber is spun into a thread of yarn to create cotton fabric. In addition to fabric, cotton is also used in a variety of products including coffee filters, tents, fishing nets, and manufacturing explosives like nitrocellulose. It is also used in bookbinding and the production of cotton paper. 

The price of cotton as a commodity is influenced by various factors like weather conditions, crop diseases, geopolitical factors, and changes in worldwide demand. 

Wheat

Similar to Corn, Wheat is also a cereal grain and is one of the most important crops in the world. It is the second most produced crop after cotton. The cost of wheat is also influenced by various factors like the price of oil, global population trends, geopolitical factors, the cost of substitute grains, and weather conditions that can affect the supply. 

However, the steady demand for Wheat facilitates a stable market assuaging price fluctuations. 

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Key Takeaways

  • Commodity trading is the buying and selling of bulk commodities in spot exchanges or stock markets. 
  • There are typically two types of commodities- soft commodities and hard commodities.
  • There are several ways to invest in commodities such as owning physical commodities, futures contracts, commodity shares, individual securities, and commodity ETFs and ETCs.
  • The advantages of commodity investment include Inflation Hedge, Portfolio Diversity, and the potential for huge ROI. 
  • The disadvantages of commodity investment include High Volatility, Lack of Income, and major External Risks. 
  • Oil, Palladium, Corn, Cotton, and Wheat are the best commodities to invest in 2023. 

Frequently Asked Questions(FAQs)

Q.1 How to Invest in Commodities?

Ans. There are several methods to invest in commodities such as buying physical commodities, commodity-related stocks, Commodity ETFs, ETCs, and CFDs. While physical ownership comes with its fair share of challenges, it is better to opt for Commodity ETFs, ETCs, and CFDs. These financial instruments offer exposure to the commodity’s price movement without requiring to own the raw materials of commodities.

Q.2 Where to invest in Commodities?

 Ans. Any investor can start investing in commodities through various online broker services like eToro. 

Q.3 Is it profitable to invest in commodities?

Ans. Commodities are a great way to protect against inflation, diversify your portfolio, and profit from global economic growth. However, if you want to invest in commodities, make sure to keep the allocation small and well-diversified.