Investing in commodities may not have the same luster as investing in the newest tech offering, but commodities can help minimize the volatility of your portfolio, hedge against inflation, and be physical assets, a feature that feels reassuring to many investors. Commodities are the raw materials that are consumed or used to manufacture other products. You can invest in agriculture, precious metals, or natural resources.
Commodities can be classified into two categories:
- Hard: natural resources, energy products, and metals
- Soft: products that are farmed or grown
Stocks vs. commodities
When you invest in stocks, you are investing in a company. Stocks represent ownership in a company and an investment in its future potential. Unlike a company, goods cannot go bankrupt, but the demand can decrease, which markedly affects their value. For this reason, commodities tend to be short-term investments, as it is difficult to predict demand long-term. Stocks tend to be long-term investments.
Future value of commodities
Commodity prices have traditionally risen over time because there is no real difference in their definition across time or location. A bushel of wheat remains the same year after year as prices go up. Some investors question whether commodity prices will continue to increase because technology has made production more efficient, which may adversely affect the long-term price of commodities. This is a concern for investors who are hoping investing in commodities for the long term will help fund their retirement.
How to invest in commodities
There are many ways to invest in commodities. They vary in degree of risk.
The most basic is to buy the commodity. For example, investors can purchase precious metals such as gold, silver, platinum, and palladium. Only the most knowledgeable investors generally invest directly. Also, consider that directly buying commodities requires storing, insuring, and then selling them.
Invest in mutual funds. These funds are typically professionally managed. You can buy the stocks and bonds of commodity producers. Another option is to invest in businesses whose profits depend on the value of natural resources.
Invest in futures contracts. A futures contract is an agreement to buy or sell a specific commodity for a predetermined price at a pre-specified point in time. In this case, you are not directly investing in commodities. Instead, you are investing in a contract. You are predicting that the price of the commodity will increase or decrease in the future. If this sounds like a very risky strategy, you would be correct.
Invest in an exchange-traded fund (ETF). An exchange-traded product is linked to an index. Instead of being actively managed by a fund manager, they are passive and designed to replicate the performance of a certain market or sector. ETFs are a collection of stocks and trade like stocks. An agricultural exchange-traded fund includes companies whose revenue comes at least 50% from agricultural sources.
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How commodities can hedge against inflation
Commodity prices fluctuate with supply and demand. When demand is high, the price rises, and when supply rises, the price falls. As a result, commodity prices typically move in lockstep with inflation.
Since commodities do not always move in sync with the stock market, having a percentage of your investment in commodities can help protect against large shifts, especially declines, in the market.
COVID-19 induced lockdowns decreased the demand for many commodities, causing their prices to fall. As the market improves and production ramps up, commodity demand is increasing. Speculators and investors try to predict which commodities will be in the highest demand.
Some commodities, such as gold, are more affected by inflation than others.
Commodities are volatile
Since the price of commodities varies with supply and demand, they can be especially volatile. Currency fluctuations, government policies, and geopolitical events can all affect commodity pricing. This volatility separates the speculators from the investors. It is important to know the risks and rewards associated with investing in commodities and only invest what you can afford to lose.
Each commodity has different factors that impact its success. The weather has a tremendous impact on the supply of crops, but not as much on oil supply. Betting on the direction of a specific commodity is speculative and best left to experts. Newer investors may be more comfortable investing in a wide range of commodities to help offset any major shifts in supply and demand.
Should you invest in commodities? It all depends on how risk-averse you are and how well you know the market you are investing in. Investing in commodities is considered riskier than investing in stocks and bonds because of the many variables that can affect commodity pricing.
Commodity investment can be complex and risky. Consulting a financial advisor ensures your portfolio is balanced and aligns with your financial goals.
