Investing in Commodities: All you need to know
What are Commodities ?
Commodities are a broad range of agricultural goods and raw material that can be publicly traded.
They are tangible assets like metals, fine wine, petroleum, and financial instruments like foreign currencies and stocks that can be traded on a commodity exchange.
Investing in commodities has historically been out of reach for everyday investors – with commodities investing typically reserved for institutional or sophisticated investors.
That has changed in recent years with the rise of exchange traded funds or ETFs – which have given investors the ability to easily invest or gain exposure to a wide range of commodities – from gold, oil, silver, cattle, wheat, eggs and more.
Like regular ETFs – commodity ETFs are pooled investment funds made up of a variety of different assets – including commodities derivatives (like oil futures) and / or physical commodities (like physical gold).
Commodities are of two categories:
- Hard Commodities: Hard commodities are commodities sourced by mining or drilling like metals (including gold and aluminum) and energy resources (like crude oil, natural gas, and unleaded gasoline.)
- Soft Commodities: Soft commodities like like corn, wheat, and soybean are products obtained through agricultural practices.
What are the benefits of commodities investing?
From diversification, hedging against inflation, and the prospect of outperformance, there are many reasons that commodities investing might be attractive to individuals.
Diversification & Inflation hedge
Beyond products like stocks and bonds, commodities, including precious metals,
give investors the chance to further diversify and increase the efficiency of their investment portfolio. Citing recent studies, commodities provides high returns when stock and bond are at their weakest, and that hedges against increased inflation. For those with allocations to risk assets – like US stocks – exposure to precious assets act as an effective ‘risk-managemen. and provide ‘effective diversification’
What impacts the price of commodities?
Like stock investing, the factors that contribute to the price of commodities are incredibly complex and oftentimes unpredictable.
Here are two factors to help you get a sense of what impacts the price or value of different commodities.
• Supply and demand:
In economics, when you have a fixed supply but increased demand, the price of the item in question will usually go up.
One of the most well known examples of this is the price of lithium.
According to S&P Global data, the price of lithium carbonate – a key ingredient in the production of electric vehicle batteries surged from just US$5,180 per tonne in 2010 all the way up to US$75,000 as demand for the commodity shot up. as a result of the electric vehicle boom.
While lithium prices have come down significantly since that peak, such an example shows how sensitive commodities can be to long and short term shifts in demand, and how certain mega trends’ can catapult the price of commodities higher.
• Geopolitics and governments:
Geopolitics and the intervention of governments in markets – can have pronounced impacts on the price of certain commodities.
In 2020, Vale – one of the world’s largest iron ore miners was ordered by the Brazilian government to shut down its Conceição, Cauê and Periquito mines following a covid-19 outbreak.
While these three mines might sound insignificant, those mines alone made up around 2% of the world’s total iron ore supply. In response to this move from the Brazilian government, iron ore futures prices jumped, as the market recalibrated its expectations of total iron ore supply for the coming quarters.
This shows how even slight changes by governments – and slight changes to the supply-demand equation of commodities can have outsized impacts.
Beyond those factors listed above, extreme weather conditions, changing consumer preferences, and technological advances can also impact commodity prices.
How to invest in commodities
- Precious Metals (Gold & Silver)
Gold has been readily used as an alternative currency in weak economies, commonly referred to as the gold standard.
Gold has long been considered a store of value and a hedge against uncertainty in times of elevated volatility.
The precious metal has been a remarkable store of value over the long run, with a single ounce of gold worth US$1,993 as of 24 March 2023.
But why is gold so valuable and why is it so coveted by investors?
Gold derives its value from its scarcity, its functionality, including it in the production of high-value and Its value was supported by a stable U.S. dollar and continued demand from central banks. The yellow metal was also sought by investors as a portfolio diversifier, particularly during the mini-banking crisis in March 2023.
How to invest in Gold
Here are the ways individuals can invest in gold in 2023.
• Physical Gold bars/jewelry/coins
The first way is to buy physical gold – including gold coins, bars, or other gold products. There are a few drawbacks to this method, including the need to securely store your gold and the potential difficulty you might encounter when trying to sell your gold.
• Investing in gold ETFs & stocks
For the majority of investors, buying gold stocks or ETFs is likely the easiest and most suitable way to invest in gold in 2023.
When you invest in a gold stock or ETF you don’t have to worry about storage, have significantly more investment choice, and selling your investment to potentially realise a profit is just a swipe away.
For investors looking to gain exposure to the price movements of physical gold, without the drawbacks of owning gold directly – the iShares Gold Trust or IAU – might be an option worth considering.
This ETF gives investors exposure to the daily price movements of gold bullion, has returned 8.08% per annum since inception, and has fees of just 0.25%.
For those more interested in investing directly in gold resources companies, one popular gold stock is the US-listed Barrick Gold – trading under the ticker GOLD – one of the world’s largest gold producers.
In 2022 Barrick produced 4.1 million ounces of gold, generated US$432 million in earnings, and returned US$1.6 bill to shareholders.
2. Industrial Metals
Industrial metals like copper and aluminum also show good price appreciation. It is estimated that the price of copper will double in the next five years, thanks to growing demand.
Copper is an essential raw material used in building homes electronic vehicles, cookware and colar power.
Similarly, the demand for lithium, a primary industrial metal used in the production of EV batteries, is expected to grow. As top economies start prioritizing decarbonization and move towards greener energy sources, the demand for industrial metals will also grow. In the US, for example, President Joe Biden proposed a $2.25 trillion American Jobs Plan that includes a $174 billion investment in the EV sector.
How to invest in copper?
If you’re looking to invest in copper you can do so buy buying shares and ETFs of copper mining and production companies.
• Russell points to Steel Dynamics. “STLD which was added to the S&P 500 in December 2022,” so a significant company in terms of size.
• VanEck Vectors RareEarth/Strategic Metals ETF (REMX). This is an ETF that invests in a set of companies in the so-called rare-earth metals-a set of minerals of critical importance in many industries.
3. Energy
Energy has historically moved very closely with
inflation as changes in this commodity affect every household – directly or indirectly.
From fueling transportation to powering factories, energy affects every sector of an economy. Even though the shift towards greener fuels has gained momentum.
From fueling transportation to powering factories, energy affects every sector of an economy.
However, it is important to note that the global investment in oil and gas supply has gradually declined since 2014. So, if you’re looking for a long-term investment, this asset class may not be the best choice.
Here are a few reasons why alternative investments counter inflation.
- As the demand for various products increases, the need for the commodities used to produce them also increases, resulting in a rise in commodity prices.
- Commodities have a low correlation to traditional asset classes like mutual fund and stocks. This means if the prices of stocks reduce, the prices of commodities rise.
- Commodities are also affected by supply-and-demand dynamics. For example, if there’s a big harvest of a specific crop, its price usually goes down. Contrarily, drought or flood can make prices rise from fears that future supplies will be affected.
- Compared to other assets which are used to combat inflation risk, commodities offer higher returns
- Commodities are liquid investments and they can be easily traded except real estate which isn’t so liquid.
You can invest in commodities either through physical products, commodities producing and mining companies and ETFs or index funds.
Here are a list of commodities that you should consider adding to your portfolio:
• Spirits/Wine
• Precious Metal e.g Gold/diamond
• Industrial Metal e.g Lithium (this commodity is doing so well at the moment)
• Energy (crude oil, natural gas, petroleum products)
• Real Estate
• Agricultural: Wheat, corn and soybeans
Now that you know about Commodities you should consider investing in them to diversify your investment portfolio.
