Commodities are becoming increasingly popular investment vehicles as investors are gradually realizing how pervasive and potentially profitable commodity trading can be.
Commodities like oil, natural gas, gold, wheat, corn and copper are a part of our everyday lives after all and their prices naturally impact us in various ways. So the more predictable the price of a commodity – the better and more stable prices are for everyone: from producers and manufacturers to transportation hubs and then from sellers to consumers.
Exchanges were first created to establish a futures market based on agricultural products or a place where standardized contracts are traded for precise quantities of a commodity to be delivered at predetermined date. Costly, unpredictable price fluctuations consequently became less common.
Nowadays, there are many exchanges that focus on uncommon commodities: fish, orange juice, trade freight containers, economic indicators, carbon dioxide (carbon credits) and even the weather forecast. Anything that needs a hedge against loss/or preserve profit and has interested speculators is fair game. Of course, along with new commodities, new and easier ways to trade commodities were also invented.
Ultimately, it takes a long-term view to be suited for the volatility associated with these markets to succeed however you decide to invest in commodities.
Futures – traditional but very risky
Long ago, to trade commodities one had to trade commodity futures and you can still trade this way currently. You need to simply open an account with a futures trading firm, obtain the needed front-end trading software and put up a substantial amount of money.
Of course, this method is not for every investor. Futures trading is actually extremely risky and requires professional trading skills and uncommon devotion. An ability to comprehend the essential markets and technical analysis are required to thrive.
Exchange Traded Funds (ETF) – tricky and problematic
An ETF is an investor’s instrument that trades much like a stock that tracks the price of another instrument. Term structures are the pricing patterns for future months. When the price of a commodity is higher in the future than right now – the term structure is in ‘contango’ but if the commodity’s price in the future is actually lower than it is now – it is said to be in ‘backwardation.’
Commodity ETFs that are driven by supply and demand like grains or energies are often bad for investors as they are perplexing even to seasoned investors as some of the outcomes seem counterintuitive.
There are about 150 commodity exchange-traded products in existence today. They’re all relatively expensive. Management fees can also be costly. And ETFs generally require professional knowledge to make good choices. The supply/demand crosscurrents that may buffet a particular commodity can be startling and frustrating for average investors.
Mutual Funds – companies versus commodities
Mutual fund commodities offer not only portfolio diversification because they typically have a low correlation to a broad market index but also diversify various commodities within a single fund. However, there are a variety of fund types with a variety of risks: commodity funds, commodity funds that hold futures, natural resource funds and combination funds.
Like sector ETFs, most mutual funds and index funds don’t directly invest in commodities but invest in companies that are closely tied to commodities. So if the commodity does well then the company will probably also do well. Most of these types of funds are not sector-specific but try to gain exposure to many commodities through the purchase of stocks. Commodity index funds are formulated to track the performance of a particular commodity index.
Binary Options – risky but easy and fast
Commodities can also be traded with Binary options , these are financial derivatives that investors use to not purchase an actual commodity but to speculate whether the price of a chosen commodity like gold goes up or down within a specific time period.
So if an investor watches the oil market, trend-lines and news about oil – he or she might purchase oil options with an expiry of 15 minutes on average. It’s hard to predict whether an asset will go up or down in such a short time period and that’s why there is still risk associated with binary option commodities. However, trading binary options requires much less expertise, time and funds to invest than all other methods of commodity trading.
Conclusion – without risks, there are no rewards
Commodity trading is fundamentally risky with any method. An unexpected drop in the amount of rainfall can drastically affect orange juice futures. Disease can wipe out entire herds of cattle. A rogue nation like Iran could attempt to close the Straits of Hormuz – the gateway to the Persian Gulf and many Mideast oilfields – and then oil could swiftly rise beyond what anyone could have reasonably predicted.