There have been many sudden price changes in commodities over recent months. This has led to many impressive news headlines and many enquiries about the increasingly high value of certain assets. Many of our clients have asked us about commodity investing and how it can add value to their existing holdings. And so we thought that today we’d take an in-depth look at this topic.
Investing in commodities can be a tricky thing to do. This is because commodity prices can fluctuate wildly – much more so than with other investments such as stocks and bonds. And if commodity prices do drop, it can sometimes take months, if not years, for them to recover.
For example, in 2007 the oil price was trading at 147 USD a barrel, and now in 2022, it trades for 95 USD. Another example is the price surge for arabica coffee, which traded at 3.35 USD per pound in 1977, and now trades at 2.25 USD. Again, these figures haven’t been adjusted for inflation. It’s important to realise what the market dynamics are like and what kind of price swings you could be in for.
What Is Commodity Investing?
With this in mind, let’s first look at the main types of commodities. There are three main types of commodities: food, energy, and materials.
As with other types of investing, there is a certain degree of risk involved with commodity trading. Some of these risks may differ significantly to the risk you take when investing in stocks, bonds, ETFs, currencies or cryptocurrencies. For example, when you’re thinking about investing in commodities, you need to pay specific attention to things like weather, local legislation, technological advancements, and the current geopolitical situation.
What Impacts Commodity Prices?
As you may already know, commodity prices are determined based on the supply and demand dynamics for each item. For example, if there is bad weather, or an attack on an oil refinery, then this can impact the global prices of those commodities. This is because these types of events would lead to a drop in supply for that item. They would also reduce the amount available on the global markets. This, in turn, can cause price surges for that item.
As the commodity markets are global markets, it is important to analyse the situation globally, and not to focus too much on what is going on in the US. For example, if we look at the current conflict between Ukraine and Russia, we see that it has had a big impact on global commodity prices. And this is true for many different types of commodities – including food and energy.
How Long Do You Need To Invest For?
When it comes to commodity investing, timing is what matters most. You need to consider whether or not you are in for the short term or the long term. As we have seen, for this type of investing, the typical buy and hold strategy may not work. Unlike stocks, where your portfolio can grow with time, here it can take decades for prices to recover.
That doesn’t mean that you should avoid adding commodities to your investment portfolios. It is simply a matter of understanding the risk and of knowing how to make the most of the potential gains. In fact, if you have a well-balanced portfolio, then investing in commodities can help you to reduce your overall risk, as commodities have a low correlation with SP500, for example.
How To Invest In Commodities
Investing in commodities typically takes place in the futures markets, where market participants speculate on the price of the underlying item. It can also take place in the spot market, by purchasing and holding the commodity. However, here, you need to consider factors such as delivery, storage, and insurance fees, as well as any other administrative costs associated with commodities.
Another option is to invest in the stocks of a company that produces, refines or trades that type of commodity. This is probably the type of investing that you may be more accustomed to, especially if you are also interested in stocks trading.
In addition to this, you can look at investing in ETFs and Mutual Funds. Focus on ones that track the performance of your chosen basket of companies, sector or commodity. There are many funds to choose from and be sure to do due diligence on before investing. A good way to start can be to divide them into passively and actively managed funds. It is worth considering the passively tracked funds. This is because they closely track and mimic the performance of a group of companies representing the sector or the commodity that you want to invest in. They also apply discretionary trading strategies and cherry-pick how, when, and what to invest in.
Commodities investing does come with some risk. That said, it can be a great to diversify your portfolio and add value to your existing holdings. There are lots are way to invest in commodities, from trading futures to investing in relevant stocks. If you want to learn more about how to invest in commodities, feel free to contact our portfolio management team. If you want to learn more about investing in general, please feel free to browse our blog.
Risk Warning: The information in this article is presented for general information and shall be treated as a marketing communication only. This analysis is not a recommendation to sell or buy any instrument. Investing in financial instruments involves a high degree of risk and may not be suitable for all investors. Trading in financial instruments can result in both an increase and a decrease in capital.