Updated on March 30, 2023
In light of the world’s current economic state, new investors might be inquiring about the advantages of commodity investing, especially with so many more ‘lucrative’ options. Investing in commodities has existed in some form or the other since the time human beings created systems to facilitate trade. However, before we tackle the advantages of commodity investing, let’s briefly define them.
Commodities are goods like wheat, gold, oil, natural gas, and many others. Investors can purchase physical commodities such as wheat, gold, and oil. The intention is to buy low and sell when the market is high. Alternatively, investors take part in commodity investing by purchasing stocks of companies that trade in specific commodities. They may participate through sector-specific mutual funds, futures contracts, or ETFs.
Types of commodity markets
Spot markets are a vital part of commodity trading because they make it possible for investors to purchase commodities on short notice. They include energy commodities like coal, oil, and electricity; agricultural commodities like wheat, sugar, and soya beans; metals like gold, silver, and platinum. Buyers participating in spot markets are further divided into commercial customers and speculators.
Commodities traded on exchanges have few quality grades and have a sizeable market of willing players. Price determination is the primary goal of these exchanges. This is because prices are regularly monitored and published. These set the benchmark for players trading outside the exchanges.
Commodities traded through auctions or bilateral contracts result in the physical delivery of the commodity in question. Auctions and bilateral contracts make it possible for prices to be determined and agreed upon outside the exchanges. Bilateral transactions typically take place in instances of international trade.
Commodity derivatives are financial instruments that make it possible for investors to profit from commodities without actually owning them. Under a derivatives contract, the commodities are exchanged at a specified future date and price. Derivatives like forwards, futures, swaps, and options are essential in commodities’ pricing and risk management.
Advantages of commodity investing
Commodity investing allows investors to diversify their portfolios by investing in companies or ETFs with different types of commodities. A well-balanced portfolio is sure to have a few winners. This is the perfect hedge against the risk that accompanies other investments. This is especially true when the economy is faced with inflation. As prices continue to rise, other investment avenues, such as stocks and bonds, suffer. Conversely, this is precisely the time when commodities seem to shine. With a portfolio combining commodities and other investments, an investor would be in a good enough position to weather the storm.
Although individual commodity prices can fluctuate widely owing to many different factors, there has been a general rise in the prices of most commodities due to various macro factors. With the increase in commodity prices, company stocks have performed better as well. Investors with positions in the commodity market have seen massive gains in recent years and might still be following that trajectory.
Geo-political factors such as Russia’s invasion of Ukraine and the recent covid 19 pandemic created abrupt supply disruptions that resulted in shortages of certain products across the globe. This increased gains for those investors who were smart enough to predict the possible outcomes and take positions accordingly.
Hedge against inflation
Inflation is the great nemesis of stocks and bonds- with every increase in inflation, stock and bond prices have taken a tumble leaving many investors weary about the future. Commodities offer a great hedge against unexpected headwinds that might affect an investor’s portfolio.
Although inflation spells doom for stock and bond investors, those investing in commodities would have reason to celebrate. An increase in commodity prices would mean bigger returns for commodity investors- this is especially true for agricultural commodity investments.
Commodity investing allows investors to leverage their positions in order to accrue higher returns. Through margin trading, investors can enhance their profits by taking strategic positions. With margin trading, the potential for profits can be significant even when the prices make a small leap. The minimum margin requirement for different commodities may vary, but this is still less than what is required when investing in equities.
The commodity market is one of the most developed and highly regulated. The possibility of market manipulation is slim because, with the use of technology, trading processes are transparent enough for different players to monitor. This is further enhanced by the sheer number of players in the market, who keep each other in check.
In conclusion, the advantages of commodity investing include the potential for high returns, hedging against inflation, leverage, and transparency. The commodities market is well-established and highly regulated, which makes it the perfect avenue for beginner investors to learn slowly with minimal risk and the potential for great rewards.
What are the Advantages of commodity investing?
- Potential returns
- Hedge against inflation
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