Let’s start with the definition of commodities. Commodities are simply raw materials people use to sustain life. There are three major classes of commodities: metals, energy and agricultural products.
Metals: gold, platinum, iron, copper, etc.
Energy: crude oil, coal, natural gas, etc.
Agricultural products: soybeans, corn, wheat, beef, coffee, etc.
In order for commodity to become an investment vehicle it has to match three main criteria. The commodity has to be tradable, deliverable and has to have liquidity (an ability to be converted into money or into another asset).
Commodities are a great investment vehicle and it provides investors and traders with unlimited possibilities in terms of profit. Some types of commodities have low volatility (low risk) and some can be quite risky for an investor.
Are commodities risky to invest?
As any other investment vehicle, commodities inherit risks of price volatility due to influence of many factors (macroeconomic factors, demand, political conditions, etc.)
What makes commodities riskier than some other investment assets is the fact that commodities are usually being traded in forms of future contracts.
Future contracts are specific vehicle with the underlying commodity, where the buyer buys the contract at the current market price, while the commodity itself will be delivered in the future (for example in half a year). For the real buyer (not a speculative trader) of a certain commodity, futures are the certain type of insurance that guarantees him that commodity will be delivered at a fixed price whatever the changed conditions and whatever the jump of a price at the moment of actual delivery.
For the investor who trades commodities future contracts, futures pose an increased risk as contracts are traded with margin leverage. That means the investor has to have only about 10-20% of the actual price of the future contract, while the rest (virtual money called leverage) is given by the broker.
It’s beneficial for the investor, as he can earn way more with the leverage, but on the other side, in a case of loss, he will lose accordingly to the size of leverage he trades with.
How much money you need for making investment?
Everything depends on whether you are going to invest in real future contracts by buying them on commodity exchange, or you prefer speculative investment through trading futures with leverage.
By entering the website on any commodity exchange you may see the market prices of any available commodity from gold to soybeans. Calculate the cost of the contracts based on market “ask” price.
For speculative trading you will need to open an account at a broker who provides you with an instant online access to commodity exchange.
Obviously, the broker charges a fee for services.
TOP-5 commodities people prefer to invest in
Investing in gold is probably the most common and the most known way to gain a profit amongst private investors. Gold bars, coins, futures contracts and gold certificates are extremely popular as gold is a universal commodity. Gold’s value never drops in a long run. Even in times of global financial crises when all investment vehicles plunge in price, gold is the only commodity which rises in value. Besides, many assets are secured by gold, which means the asset is reliable is valuable. Still, trading gold with leverage can put your whole portfolio under risk due to gold’s high intraday volatility.
One of the most popular commodities among investors and traders is crude oil which is a base of various petroleum products: gasoline (petrol), fuel oil, kerosene, etc.
The price of crude oil futures can jump up and down heavily within a day frames, so this commodity is considered a risky one (still not that risky as currency and precious metals trading). Oil futures are traded at NYMEX – New York Merchant Exchange.
Crude oil price is heavily affected by political factors, along with the volume of demand, and some other macroeconomic factors.
Analysts have already announced copper the best performing commodity to invest in 2017 year. It’s a metal which is extensively used in different alloys (like bronze). Copper is an essential element of electrical wiring, electrical appliances, heating and cooling systems. It is also widely used in medical technologies and equipment.
The price of copper is not so volatile as gold or silver, and therefore copper futures are often considered an instrument of moderate investment strategy. Copper is also traded at NYMEX via commodity division called COMEX (stands for Commodity Exchange).
Cocoa (the “food of gods”) is mainly traded in forms of futures contracts with the following months of delivery: March, May, July, September and December.
The trading symbol of Cocoa at ICE (Intercontinental Exchange) is “CC”. There are two kinds of cocoa commodities: Forastero and Criollo. If you have decided to invest in cocoa commodity you should know there are numerous factors which influence its price, such as: yearly amount of cocoa production (it can vary massively), climate change, and political situation in areas where cocoa is produced and lots of other factors.
Commodity future contracts for coffee are traded by the same concept as other commodities. Speculative trading can be challenging and risky but rewarding at the same time. There are two types of coffee traded on exchange: Arabica and Robusta and the price of both types are affected by several factors you should know and be informed about regularly (as an investor or trader): climate factors, geopolitical situation, world demand, enterprise trading and others.
What are the mechanisms of investing in commodities?
If you are a private investor and willing to get a profit from deals with commodities, you may choose of (or several at once) the following ways to invest.
- Through futures contracts
By getting an online access to one of world’s commodity exchanges
- Through commodity pools
Commodity pools or Managed Futures gather numerous separate amounts from private investors in order to buy bigger lots of commodity futures and share the profit amongst participants afterwards. You also may become a participant of Commodity pools with as moderate amount of money as you are willing to invest.
- Through buying stock of commodity related companies.
Investing in stocks (by buying) of companies that relate to a certain commodity production or mining (in case of metals and oil) you indirectly invest in commodities. If the price of the certain commodity rises, the shares of the companies related to this particular commodity immediately go up. You gain your profit and your whole portfolio becomes more efficient.
- Dealing with Mutual Funds
Mutual funds allow you to become a part of investment pool where you may choose preferred investment vehicles (commodity futures in our case).
All portfolios in Mutual Funds are managed by specialists-traders, so there is a big probability you’ll gain more profit from commodities via mutual funds rather than trading it on your own.
- Through ETF and ETN
ETF stands for Exchange traded funds (where commodity-based indexes are traded), and ETN stands for Commodity-Linked Exchange-Traded Notes which you can use as a way to invest in commodities.