Investing In Commodities: A Beginner’s Guide

lKey Takeaways


It has long been proven that a diverse portfolio is the best way to minimize risk and maximize profits as an investor. After all, spreading out your assets offers protection against market changes — something that is becoming increasingly important in today’s world. It turns out investing in commodities can be a great opportunity to do just that.

If you have tried your hand at more traditional investments (such as real estate, stocks, or bonds) it can be a good idea to start branching out. Luckily, working with commodities is not as complicated as it may seem. There are multiple ways for investors to begin seeing profits from commodities, all you have to do is a little research to get started.

What Are Commodities?

Commodities refer to any uniform resources that are considered to be basic goods. A few well-known examples are wheat, corn, and oil. Each of these resources can be used in a variety of ways, and are oftentimes in demand all over the world. Trading commodities is a practice that dates back hundreds of years, and today there are even more ways to see profits from commodities. These include exchange-traded funds (ETFs), futures contracts, and options.

There are two main categories of commodities: soft and hard. Soft commodities refer to items that are grown or ranched, such as rice, corn, soybeans, and livestock. Hard commodities are resources that must be mined or drilled, like coal, gold, aluminum, and gas. This distinction is helpful when searching for investment opportunities.

Despite a global demand for many commodities, there is still some risk involved to be aware of before investing. Every market is going to be subject to some uncertainties, and commodities are no different. For example, during the COVID-19 pandemic, there has been a dramatic decrease in oil demand. However, by diversifying your assets you can help safeguard your portfolio with commodities and mitigate some risk.


[ Do you control your finances or are your finances controlling you? Find out how real estate investing can put you on the path toward financial independence. Register to attend a FREE real estate class, upcoming in your area. ]


commodities definition

Types Of Commodities

There are four main types of commodities to be aware of: agricultural, livestock, energy, and metals. These distinctions can help you identify practical investment opportunities that fit your risk tolerance and financial goals. Here are a few examples of each:

  • Agricultural: These commodities essentially refer to crops within the agricultural sector. Popular agricultural commodity examples include coffee, cocoa, wheat, cotton, sugar, and corn. The risks associated with these commodities center around seasonal and weather-related changes. While profits are typically driven by population growth and limited agricultural supplies.

  • Livestock: The other half of what many people typically associate with agriculture is livestock. This type of commodity deals specifically with cattle, chickens, hogs, and other animals. While there is less uncertainty when compared to crops, there are still some risks involved in livestock commodities.

  • Energy: Energy is one of the most well-known types of commodity and includes crude oil, natural gas, gasoline, and heating oil. Demand for energy-related products has for the most part increased consistently throughout history as a result of development. Investors should be aware that economic downturns can negatively impact the market for energy-related commodities, as we have seen throughout 2020.

  • Metals: Metals refer to commodities that must be mined and are often described as either base metals or precious metals. Base metals are used for industrial purposes, such as zinc, steel, aluminum, lead, and nickel. Precious metals typically have higher value and are used for investment or decorative purposes. Precious metals include gold, silver, platinum and ruthenium.

What Is Commodity Trading?

Commodity trading is the practice of buying and selling various resources. The practice is hundreds of years old, though it looks a lot different now than it once did. Commodity trading used to focus on materials and spices, which facilitated cultural exchange around the world. Today, investors can not only purchase physical commodities, but they can also buy shares in commodity companies, ETFs, or mutual funds.

When managed correctly, commodity trading can be a great way to diversify an existing investment portfolio. This is because commodities often benefit from a steady demand, allowing investors to maximize their returns. While commodities are subject to some market fluctuations, commodities can offer protections against inflation or times when the U.S. dollar declines in value.

How To Invest Commodities

There are several ways to invest in commodities, each with unique benefits and risks to consider. Investors should research each type before choosing a strategy (or two) for their portfolios. The five main ways to invest in commodities are:

  1. Buying stocks in companies that produce commodities

  2. Purchasing futures contracts

  3. Buying shares in exchange-traded funds

  4. Using mutual and index funds to trade commodities

  5. Working with commodity pool operators

How To Use Stocks To Invest In Commodities

Stocks are perhaps the most straightforward method of investing in commodities. To get started investors can simply purchase shares of a company that deals with commodities. For example, those interested in metal commodities could buy shares in a mining company that focuses on gold. This option is especially attractive to investors who are unable to make a large initial investment.

The risks associated with commodity stocks typically center around the companies themselves. Prices may be negatively influenced by business operations or other company-related factors, as opposed to just the actual value of the commodities. Unfortunately, there is not a way to reduce this risk completely but investors can heavily research the companies before purchasing stocks.

How To Use Futures To Invest In Commodities

Futures are a great opportunity to invest in commodities, especially if you are familiar with the market you are investing in and are interested in speculating on price changes. Futures contracts are essentially agreements made to buy or sell shares at a certain time in the future, for a predetermined price. Investors can profit from futures contracts when the value of the commodity changes. This can be done on a short or long-term basis.

Getting started in futures contracts does involve a lot of research on the industry, and is typically not recommended for beginner investors. The reason is that a lot of futures investing revolves around speculation. Investors can however work with a broker, or opt for contracts with an option to buy. These methods can help investors who may not be familiar with market analysis benefit from the profitability of futures.

How To Use ETFs To Invest In Commodities

ETFs are a great option for those who are interested in fluctuating commodity prices but don’t want to necessarily purchase futures contracts. ETFs refer to exchange-traded funds and act as a collection of securities. They can be bought and sold similar to stocks, with prices changing throughout the trading day. Investors hoping to purchase commodity ETFs can do so with the help of an online or traditional broker. It is worth noting that not all commodities have associated ETFs; therefore, investors with a specific commodity in mind may need to look elsewhere.

Using Mutual & Index Funds To Invest In Commodities

Mutual funds can be a great vehicle for investing in companies that deal with certain commodities. While this opportunity does not allow investors to directly work with the commodity, there are several protections associated with mutual funds to consider. For the most part, mutual funds are known for their professional management and liquidity. This makes these funds a great option for investors hoping to profit from the companies that deal with commodities, without directly buying stocks themselves. In many ways, this can be a good gateway into commodity investing. Again, investors will need to be aware of market fluctuations and company-specific news. However, the right mutual fund can provide some insight into this process.

Using Commodity Pools To Invest In Commodities

Commodity pools are a way to combine resources from a group of investors to purchase futures contracts and options. The commodity pool operator (CPO) will distribute account statements and annual financial reports to the investors involved. The combined structure of a commodity pool will typically allow for larger investment opportunities to be made.

Each pool will typically employ an advisor who is required to register with the Commodity Futures Trading Commission (CFTC). Advisors are then able to provide investment advice on the various options. Similar to mutual funds, investors will often choose to work with commodity pools because of the added benefit of a financial advisor.

What Are The Best Commodities To Invest In?

When choosing a commodity to invest in, there are two important factors to consider: supply and demand. While most commodities benefit from a consistent or global demand, some have performed better over time than others due to their limited supply. Beginner investors should consider these commodities as a great place to start:

  • Crude Oil

  • Gold

  • Base Metals

Crude Oil

Crude oil has long been a popular commodity investment due to its many uses. Crude oil can be used not only for gasoline but also petroleum products — which include plastics, asphalt, fertilizer, solvents, ink, and even cosmetics. There are multiple ways to invest in oil, though some can require high amounts of capital to start in. Investors who are interested in crude oil investments can purchase stocks in oil companies, ETFs, and even mutual funds.

One of the biggest risks associated with crude oil is that its profitability is highly susceptible to changes in demand. As mentioned above, oil is one of the many investment types to be negatively impacted by the events of 2020. That being said, it remains a necessary commodity all over the world.

Gold

Most people think of an investment in gold as the purchase of jewelry or old gold coins. In reality, there are numerous ways to purchase this commodity — each of which can be profitable when done right. Gold can be a highly attractive investment because of its performance against inflation. Typically, as the value of the U.S. dollar decreases, gold prices increase. This makes investing in gold a common route for investors looking to diversify their existing portfolios.

There are a few different ways to invest in gold including buying physical gold, futures contracts, or stocks in gold mining companies. Each of these investment types does come with its own set of risks and benefits, but as a whole can offer investors the opportunity to profit from this precious metal.

Base Metals

Base metals are a popular commodity to invest in because of their consistent global demand. These metals are known for their use in commercial and industrial industries and are commonly found all over the world. This makes base metals relatively inexpensive to invest in, while also still having the potential to yield high profits. Although, investors would have to purchase large amounts of the materials to see returns from the physical commodities. Because of this, the most beginner-friendly way to invest in base metals is often by purchasing stocks in mining companies.


[ Do you control your finances or are your finances controlling you? Find out how real estate investing can put you on the path toward financial independence. Register to attend a FREE real estate class, upcoming in your area. ]


define commodity

What Are The Best Commodity Stocks & ETFs?

As you begin researching commodities stocks and ETFs you may be surprised by the sheer amount of options available. A good rule of thumb is to begin by researching a specific commodity — and then looking through each of the main players in the industry. When it comes to commodity stocks, these are the main companies to help you get started:

  • Valero Energy: Gasoline, heating oil

  • Tyson Foods: Cattle, pork

  • Archer-Daniels-Midland: Corn, wheat, and other agricultural commodities

  • Anglo-American Platinum: Base metals

  • Barrick Gold: Gold

  • Freeport-McMoRan: Copper, Gold, and energy products

  • ExxonMobile: Crude Oil

Those interested in ETFs should follow a similar process. Begin by looking into the commodity type you are interested in and then research different funds. Some of the most commonly available ETFs are as follows:

  • VanEck Vectors Gold Miners

  • Teucrium Corn Fund

  • Aberdeen Standard Physical Silver Shares

  • United States Oil Fund

  • iShares Silver Trust

  • SPDR Gold Trust

Related: What Are Alternative Investments?

Summary

Trading commodities is one of the oldest forms of investment types, dating back hundreds of years. Even today they continue to offer a high profit potential because of steady global demand. While commodities are not entirely immune to market fluctuations, they can still be a great opportunity for those looking to diversify. Investing in commodities can be done in several different ways, with options catering to various levels of experience and capital. What they all have in common is their ability to expand even the best investment portfolios.

Have you ever invested in a commodity type? Share your experience in the comments below.

Do you want to be able to retire financially comfortable?

Our new online real estate class can help you learn how to invest in rental properties that can help increase your monthly cash flow. Expert investor Than Merrill shares the core real estate investment principles that work best in today’s real estate market.

Register for our FREE 1-Day Real Estate Webinar and get started educating yourself on how to invest in today’s rental real estate market!

🔒 Your information is secure and never shared. By subscribing, you agree to receive blog updates and relevant offers by email. You can unsubscribe at any time.
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies