We couldn’t live without commodities. Although the assets traded on the markets can sometimes seem unreal and abstracted, all of us can comprehend the reality of these investment instruments, and that’s why so many people choose to trade them. We understand the factors that drive their supply and demand, and thus we understand how the markets move.
Yet it is not only their tangibility that is appreciated by traders. Commodities, whether food, energy, or metals, are also wonderful tools for diversification, and can really help to stabilise higher risk or overly narrow portfolios.
If you’ve considered investing in them yourself, however, you may have run into one rather common problem: there are just so many ways to do it. With numerous routes into the commodity markets, it can be difficult to decipher which of them would be best for you, so we’ve created this brief guide to assist you if you want to invest in commodities …
One of most common routes into commodities investing is through a futures contract. These contracts work by creating an agreement to either buy or sell a specific quantity of an asset at a set price at some point in the future, and they’re available for everything from crude oil to gold, corn, and even cattle.
The main advantage of such an approach is that it allows ordinary investors to control full-size contracts that would normally be beyond their means. Leverage also leaves open the possibility of big profits for those who make the right moves.
The downside, however, is that futures markets tend to be incredibly volatile, and thus present a significant risk to those who choose to invest in them. Additionally, the use of leverage means that gains are magnified if your trades don’t pay off, and thus potential losses can be just as high as potential gains.
Stocks are one of the most familiar investment instruments on the markets, and this makes them popular amongst those who are still testing their trading wings. Far less volatile than their futures counterparts, they allow you to sink your capital into ventures directly involved with the mining or production of various commodities.
The main advantage of choosing to trade stocks is that they tend to be highly liquid. Additionally, there is usually a large amount of public information available on their financial situation to help guide trading decisions.
On the downside, they may not always be ideal for those who want to focus purely on commodities, as stocks are not an undiluted play on commodity prices, but can be influenced by company-specific factors too. For those put off by this idea, direct investment in a more tangible asset, such as gold, may be preferable. This can be achieved through companies like Stunt & Co, and will avoid any other external stimuli affecting the value of your investment.
Exchange Traded Funds and Exchange Traded Notes
Exchange traded funds (ETFs) and exchange traded notes (ETNs) are another suitable option for those wishing to avoid investing directly in futures contracts. ETFs usually operate by tracking the value of a certain commodity, or a group of commodities that constitute an index, whilst ETNs mimic the price fluctuations of these, but are supported by an issuer.
Their main advantage is that they offer a simple and easy way to participate in such price fluctuations. Many people also appreciate their similarity to stocks, as this means that management and redemption fees are not an issue.
The major downside to them, however, is that not all commodities will have either an ETF or ETN associated with them, so they’re not always a viable investment option.
If you’re planning on investing in commodities, could one of these options be suitable for you?