When it comes to choosing the best assets, investing in commodities is a popular choice among many savvy investors. Read on to find out how you can safely invest in commodities, the reasons why you should do it, and what are the risks associated with this type of investment.
What are commodities?
Commodities are raw materials that can be found in nature or raw materials that are used in various processes in order to produce final goods. There are renewable and non-renewable commodities.
Renewable resources are infinite and can always be replaced, such as wind or solar energy. Non-renewable resources are finite, such as oil or natural gas.
Why invest in commodities?
Investing in commodities is useful to diversify an investment portfolio and to protect your capital from inflation.
In addition, the commodities market has a low correlation with the stock and bond markets. Usually, when bonds fall, commodities rise and the same happens when there are sudden shocks in the stock market.
Commodities are enjoying surging interest, typically in periods of crises, recessions, or other disturbances. They protect against inflation as their prices rise along with other goods. Hence, adding commodities to your portfolio can be a profitable move, especially in the long term when other markets fluctuate.
What is commodity trading?
Before answering the question, it is necessary to make an important distinction between investing and trading. The terms are often misunderstood.
The goal is clearly to make a profit. Traders speculate on price movements with the aim of making money in the short term or medium term.
Investing is often for several years and includes creating a portfolio to generate returns and build wealth (dividends, interest payments, capital appreciation).
|Goal: medium to long term||Goal: short term|
|Products: real assets, such as stocks, ETFs, commodities, cash, and more||Products: typically derivatives (such as CFDs, options, futures)|
How to invest in commodities?
There are different ways to invest in commodities. It is possible to buy and sell physical commodities, although the purchase of physical goods may not be practical. Instead, it is much more common to invest in financial assets instead.
One of the most well-known indices is the Thomson Reuters/Jefferies CRB Index, currently composed of 19 commodities. Regarding this index, agricultural goods account for about 40%, oil for 33%, gold and silver for 7-8%, and industrial metals for 14%.
The CRB Index initially aggregated 28 commodities, of which 26 were traded on US and Canadian commodity exchanges and 2 on spot markets. It included barley and flax from the Winnipeg commercial market; cocoa, coffee, copper, cotton, cottonseed oil, raw and combed wool, leather, lead, potatoes, rubber, sugar and zinc from the New York Stock Exchange; wheat, corn, eggs, lard, oats, onions, rye, soybeans, soybean meal and soybean oil from the Chicago Exchange.
In addition to these 26 goods, the index also included the spot price of cotton on the New Orleans market and that of wheat on the Minneapolis market.
Another important index is the RICI – Roger International Commodity Index where the weight of commodities is distributed as follows: 40% energy, 17% industrial metals, 11% precious metals, 32% agricultural commodities and 3% livestock.
Another index closely watched is the Bloomberg Commodity Index, composed of 31% energy, 17% industrial, 15% precious, 31% agriculture and 6% livestock.
Finally, the Goldman Sachs Commodity Index – GSCI was created in 1991 and is composed of 58% energy, 10.9% industrial metals, 4.7% precious metals, 18.2% agricultural commodities and 7.5% livestock.
Investing in physical commodities
Physical holding was the traditional way of investing until the emergence of stock markets and, above all, futures contracts. It consists of buying a commodity and storing it. This is common for some types of non-perishable products, such as precious metals.
However, there is a problem related to investing through physical exposure. Keeping gold at home may not be a safe option, and there are many concerns regarding security, maintenance, and other aspects.
If you keep it in the vault of a bank, you will have to bear more costs. Also, investing in commodities through physical exposure may be possible with these metals, but not with perishable commodities such as corn, sugar or livestock, which also involve transportation and storage problems.
Investing in commodities via stocks
Investing in commodities via stocks is one of the simplest ways to invest, as it involves holding stocks of companies related to commodities. Think of a sugar mill or a company that deals with the processing of crude oil. If the price of the commodity increases, the share price is likely to increase as well.
This is a very common way to invest in commodities due to convenience and the possibility of keeping an eye on prices. In addition, we have access to practically all markets that deal with commodities and we can choose the one that interests us. This is a considerable step forward compared to investing in physical commodities, which is currently practically limited to precious metals and is not suitable in many cases.
Futures contracts for investing in commodities
Futures trading is a common strategy for many traders and investors alike. Typically used for hedging purposes when paired with a long-term strategy, a futures contract allows the producer and the buyer to agree on a price and terms for the delivery of a commodity at a future date.
It’s important to note that physical delivery is rare (often used by businesses), so many contracts nowadays are settled in cash instead. In this case, the exchange becomes the counterparty of the seller and the buyer, asking them for a margin.
Commodity producers, for example, use futures contracts to guarantee the price of their products, ensuring predictability and mitigating risks.
The trader who buys the futures contract (that is, who commits to buying the underlying asset at maturity) takes a long position (long), while the operator who sells the future takes a short position (short).
Here is an example of crude oil futures:
Investing in commodities via ETFs or mutual funds
Exchange Traded Funds (ETFs) are investment funds listed on the stock market. There are differences between index funds vs ETFs. Perhaps the most important aspect to consider is if your chosen fund employs active or passive management.
Fortunately, there are many commodities funds available nowadays. A passive fund usually tracks a benchmark (a commodity index, for instance) and mirrors its performance. An active fund, on the other hand, aims to generate more returns than the given benchmark.
The benefit of investing in a commodity fund is convenience. The fund’s assets are chosen and managed by professionals, so you don’t need to pick each of them individually. As long as you choose the fund carefully, this investment option is extremely intuitive and straightforward. One example of commodity funds is L&G Commodity Index Fund.
ETCs (exchange-traded commodities) are passive replication instruments of an underlying asset such as commodities. In this case, the management costs are much lower than those of active funds where a manager is present.
The price of the ETC depends on the underlying asset (a single commodity) or index (a basket of assets). These assets allow people to invest in commodities without actually the underlying goods.
You might be interested in:
Investing in commodities via CFDs
Another opportunity to invest in commodities is via CFDs (Contracts for Difference), which are types of derivative contracts based on which the difference in the value of a certain commodity is exchanged. The trader speculates on the increase or decrease in prices in order to obtain a profit. Essentially, the CFD is a contract in which two parties agree to exchange money based on the change in value of an asset. In addition, CFDs are standardised and quickly negotiable contracts.
These are just some of the advantages, in addition to the cost-efficiency and practicality compared to traditional investments. A simple example of trading via CFDs on commodities is opening a buy (long) or sell (short) position on oil. Let’s imagine going long as you are convinced that the price of crude oil will rise. Once the position is opened, you could make a profit if the price of oil increases or a loss if the price decreases.
Through leverage, it is also possible to multiply profits while increasing the risks. With leverage 1:20, for example, with £100, you have the possibility to invest £2,000. Essentially, leverage is a mechanism that allows you to invest only a part of the value of your transaction, and the rest is borrowed from the broker.
Options on commodities
Options are contracts that give the buyer the right to buy or sell a commodity at a predetermined price at a certain expiration date. It is another way to invest in commodities. The use of options can also be used to protect an investment (known as hedging).
Trading or investing in commodities not only allows for diversification but also for making additional profits by taking advantage of price fluctuations that are fueled by multiple factors.
What commodities are traded on the London Stock Exchange?
The stock market offers a good variety of commodities to trade via ETCs (exchange-traded commodities). Before diving into this world, you should know what the main commodities you can invest in are and the best brokers to invest in commodities.
You can invest in gold and silver via ETCs. Also, you can opt for ETCs tracking precious metals indices.
Precious metals may not come with sky-rocketing returns, but they help diversify the portfolio and ensure liquidity. They are also seen as safe havens during inflationary periods and recessions.
Learn more about investing in precious metals.
These materials include iron, zinc, copper and steel, essential in producing many final goods. You can also invest in aluminium, copper, zinc, or nickel directly or buy an index ETC.
Learn more about investing in metals.
Agricultural raw materials
Within this classification, we find animal feed, cotton, or livestock.
These are mainly natural gas, coal, oil and petroleum products. On the London Stock Exchange, you can buy gas, crude oil, gasoline, and heating oil.
Learn more about investing in oil.
Perishable products are materials such as corn, soybeans, wheat and sugar.
Of course, investing in this type of raw materials is done via:
|Precious metals||Gold, silver, platinum, palladium.|
|Industrial materials||Iron, zinc, copper and steel.|
|Agricultural and livestock products||Animal feed, cotton or livestock.|
|Energy||Natural gas, coal, oil and petroleum products.|
|Perishable products||Corn, soybeans, wheat and sugar.|
Best commodities to invest in
Not all raw materials are of equal interest. Here are some of the most traded commodities:
Brent Crude Oil
Originating from the North Sea, it is characterised by being a light product and is also the reference oil in Europe. Given its conditions, it is used in gasoline production. As a curiosity, it should be said that it is a type of crude oil that is extracted from the ocean, using a technique called fracking.
Extremely popular in the industrial world, steel is one of the most interesting raw materials for investments. It has the quality of being able to be worked continuously without losing its properties and is used practically in all types of industrial plants, as well as in the urban development sector.
China is first in the world in steel production and produces nine times more than the entire European Union.
WTI crude oil
This is West Texas Intermediate crude oil, produced in North America. This oil, like Brent, determines the price of other fuels worldwide. The production of this type of crude has remained very stable for decades until the beginning of 2020.
Find out the differences between Brent and WTI.
Soybeans have been defined by many as the cereal of the future. Its global demand is very high. Brazil, the United States and Argentina are the world’s leading producers of soy. The flip side is that much of the Amazonian rainforest and forest areas of Argentina are being deforested to grow soy.
Numerous by-products are extracted from soy, including flour, milk and oil. It is also a component of animal feed.
Iron is one of the premier raw materials, a fundamental element of steel and the basis for the manufacture of a huge variety of products. The world’s largest producer of iron is Australia, with 900 million tonnes per year.
Corn is the most cultivated cereal in the world. It is used to produce vegetable fuels, intended to drive a new revolution. The United States, followed by Brazil and China, are the main corn-producing countries.
Investing in gold is perhaps the flagship investment. It is a precious metal characterised by its scarcity and can be traded with ease.
3 best brokers to invest in commodities
Not all brokers allow you to invest in commodities at competitive prices. To help you out, we’ve rounded up the best brokers to invest in commodities:
|Eightcap||Visit the broker|
|Interactive Brokers||Visit the broker|
Eightcap is one of the main brokers for trading CFDs on commodities. It offers access to markets like gold, silver, and oil, and spreads start from 0 pips, which is perhaps one of its main strengths. In addition, with Eightcap, you can access any of the most popular trading platforms in the world – MT4, MT5, or TradingView.
Check out our Eightcap review for more information.
Next, Interactive Brokers is one of the leading US-based brokers, founded in 1978, and is regulated by several global authorities. Offering multiple services, it is a reference point for professional traders.
Have a look at our in-depth Interactive Brokers review for more information.
Among the main online brokers that allow you to invest in the commodities market, eToro is one of the most popular ones. You can invest in or trade many assets. Also, thanks to its copytrading and social trading platform, you can easily copy the portfolios of experienced investors and traders within a few clicks.
Find out more in our eToro review.
Another broker with decades of experience and a very important place in the sector is certainly ActivTrades. Highly appreciated by traders for the customer support service, security, and tools, ActivTraders is one of the top brokers on the market.
Have a look at this ActivTrades review for more information.
Regarding the main ETFs on commodities, based on the one-year return, the best performances were obtained by:
- Lyxor Commodities Refinitiv/CoreCommodity CRB TR UCITS ETF with a performance of 29.7%,
- Xtrackers Bloomberg Commodity Swap UCITS ETF with a performance of 29.2%,
- L&G Longer Dated All Commodities UCITS ETF with a performance of 28.9%.
Before the recent downturns, in the last few months, the rally in commodities has had a real domino effect due to the great interest from many traders and investors.
Commodities as safe-haven assets in times of crisis
Commodities have historically been a real hedge against financial crises.
For instance, gold is traditionally known as a hedge against inflation. Even central banks, during periods of economic and geopolitical uncertainty, or high inflation, seem to turn to gold as a store of value.
In addition, it must be remembered that safe haven assets have an intrinsic value that generally tends to remain stable even in times of crisis. This aspect allows you to enjoy additional protection in times of economic recession.
Speaking of inflation and safe haven, gold has historically shown some effervescence, just think for example in the period between the early 1970s and 1979, when the average inflation rate in the United States was 8.8%, gold had a return of 35%, far exceeding other asset classes.
Outlook for commodities
The dynamics related to the prices of commodities are numerous and depend on:
- Macroeconomic factors
- Demand and supply
- Storage levels
- Value of the dollar
- Geopolitical factors
- Climate factors, natural disasters.
Gold is traditionally known as a hedge against inflation, but an increase in interest rates tends to reduce its appeal as it increases the opportunity cost of holding the non-yielding asset. Gold also tends to have a negative correlation with the dollar.
In the near future, specific types of markets could become more popular: for instance, platinum and palladium (metals used in several industries), as well as silver, which is linked to solar panels.
Don’t forget about metals like copper and other types that can benefit once we’re past the current tough times. These metals will be useful in making electric vehicles, clean energy, and things that match the goals discussed at events like the Paris Climate Conference and programs like the EU’s Green New Deal.
While OPEC Plus policies will still matter, there’s a chance that China’s economy might slow down, causing a drop in demand for a while.
Risks of investing in commodities
Lack of knowledge
It is up to investors to determine the risk they are willing to take when investing in commodities. In this case, the main risk taken is common to other types of securities – investing in assets without proper due diligence and a robust strategy can be detrimental to your future success.
Another main risk of investing in commodities is that these products are highly volatile. Just one geopolitical change is all it takes to take the market by storm.
Speculative asset types
Commodity trading is very popular due to this asset type’s volatility and potential for returns, especially when leverage is used. Leverage can be extremely risky for novice investors or traders, so you may want to learn more about trading before making any decisions.
Read more about investing and trading other asset classes
- Options trading
- CFD trading
- Futures trading
- Dividend investing
- Investing in stock market
- Where to invest in 2023?
Summary: invest in commodities
If you want to invest in commodities, there are many options to choose from nowadays. Make sure you do your due diligence before risking your hard-earned cash, create a foolproof strategy, and use risk management techniques to limit your potential losses.
What are commodities in investing?
Commodities are raw materials or primary agricultural products like metals, energy sources, crops, and more. They are traded in markets and can be valuable investments due to their essential role in various industries.
How can I invest in commodities?
There are a few ways to invest in commodities. You can buy actual physical commodities like gold or silver, invest in commodity-focused exchange-traded funds (ETFs), or engage in commodity futures trading through specialised platforms.
Why should I consider investing in commodities?
Investing in commodities can provide diversification to your portfolio, as they often don’t move in the same direction as stocks and bonds. They can act as a hedge against inflation and global economic uncertainties, making them an attractive option for risk management.