There are several options to invest in commodities, such as the futures market, contracts for difference, and exchange-traded funds
Coffee could pay for your next vacation. And no, we’re not talking about the Nescafé Salary. We’re talking about investing in commodities.
Since prehistoric times, humans have taken advantage of natural resources. Wood has enabled them to build houses, leather to make shoes, and cotton to weave clothes for warmth.
Today, it is also possible to use them to multiply wealth. And all savers who have chosen to invest in commodities know this firsthand. Although stocks and funds monopolize much of the discourse when it comes to investment, there are hundreds of possibilities beyond them in which to inject capital to obtain a return. And commodities are one of the options to consider when designing investment strategies.
But in which products is it possible to invest? What mechanisms exist to do so? Is it a safe alternative? In this article, we will analyze the answers to all these questions.
What are commodities
It is impossible to know how to invest in commodities without first knowing what a commodity is. Simply put, they are the natural resources from which other products can be manufactured. They are physical assets from the world around us that are used as raw materials to create goods and services.
Raw materials can be divided into four different categories. To begin with, there are those that come from agriculture, such as cotton, corn, coffee, sugar, wheat, cocoa, or soybeans. Next are those used to extract energy, such as oil or natural gas. Thirdly, we can find all kinds of metals, such as gold, silver, platinum, iron, or copper. And finally, there are meat commodities, such as beef cattle.
However, to invest in them, there must be a market. That is to say, a space where different buyers and sellers come into contact to exchange commodities. This market, where all transactions occur, can be physical or online.
However, it must be borne in mind that prices vary continuously depending on supply and demand. In addition, a myriad of external factors could change them, triggering or sinking investors’ profits: a global or industry crisis, an increase in transport costs, or a storm that wipes out crops.
A quick look at the history
To understand what investing in commodities is all about and why it has become such a popular choice among so many savers, it is essential to look back, specifically to 1848, when the Chicago Board of Trade was founded.
Popularly known as CBOT, this body specialized in agricultural products such as corn, soybeans, and wheat. And its establishment was a real turning point, as it became the first futures and options market in history. Fifty years later, the Chicago Butter and Egg Board was created, with which it merged in 2007 to become the Chicago Mercantile Exchange (CME).
The 1870s also saw the birth of the New York Board of Trade (NYBOT), originally called the New York Cotton Exchange. More than a century later, it merged with the Coffee, Sugar, and Cocoa markets (CSE) and became part of the Intercontinental Exchange (ICE).
At that time, the New York Mercantile Exchange (NYMEX) was born, created in 1872, and focused on dairy products. At the end of the last century, it merged with the Commodity Exchange (COMEX), giving rise to the world’s largest commodities market until its merger with the CME Group in 2008.
But let’s not limit ourselves to the United States. If we cross the pond to invest in commodities at the European level, we find the London International Financial Futures and Options Exchange (LIFFE). If we travel to the Asian market, the main body is, without a doubt, the Tokyo Commodity Exchange.
How to invest in commodities
The most obvious way to invest in commodities is to acquire the assets physically. Buying, for example, gold bullion. However, this has a significant disadvantage: the difficulty of storing them, especially when it comes to products such as oil. For this reason, it is not the most advisable option.
Some savers choose to invest in commodities indirectly by buying shares in companies in this sector. For example, if a person wants to invest in oil, he can buy shares in an oil company. If oil rises, the price of its shares is likely to replicate this rise. But many other factors influence the stock market, so the behavior of the two is not always similar.
Another popular alternative is the futures market. Here, savers agree to buy or sell the commodity in the future, deciding at present the date, price, and quantity to be exchanged. However, not all commodities have their own futures market, and some require a high investment, so it is not always a convenient option for those new to this world.
So where is it safest to invest in commodities?
CFDs and ETFs, key players
CFDs (Contract For Difference) and ETFs (Exchange Traded Funds) have become the most popular mechanisms to invest in commodities in recent years.
Contracts for Difference are a derivative instrument based on leverage. In other words, with less capital, you have more exposure. For example, if gold rises by 10 points, the investor could gain 30 points, but he could also lose them. And the fact is that CFDs, which are proportional, involve a relatively considerable level of risk.
On the other hand, Exchange-Traded Funds are funds in which shares in products that replicate the price of the futures market are bought and sold. They function as a meeting point between stocks and mutual funds. If the original commodity rises, the investor will enjoy profits. On the other hand, if it goes down, he will face losses.
There are, in short, many options available to all savers who wish to invest in commodities to obtain a return on their savings. And each person will choose the one that best suits their circumstances, considering their budget and the level of risk they are willing to take.