Commodities are basic materials and natural resources like oil, gold, and grains that have intrinsic value and come from many places. Buying and selling commodities is as old as human civilization itself, and early forms of currency were themselves commodities. Today, investors have many ways to participate in this marketplace from buying shares in a commodity fund or commodity-focused company to buying futures contracts or even acquiring, storing and transferring the items themselves.
What is commodity investing?
Commodity investing is buying and selling actual physical goods like gold, crude oil, or wheat, or financial products, such as futures contracts, related to those goods. The prices of commodities depend on supply and demand of the physical product. Investors can take part in this market by buying exchange-traded funds (ETFs) focused on commodities, or by investing in companies involved in cultivating, extracting, or processing commodities, or that have significant business operations supporting those activities.
Why invest in commodities?
Investing in commodities can be a helpful way to diversify a portfolio of stock and bonds, real estate or other assets. Commodities may be a good hedge or complement to other investments because their gains and losses aren't necessarily correlated to the stock market. Commodities can also be used as an inflation hedge. Additionally, investors may want to trade commodities if they think they have insight into what commodities will be in demand in the near- or long-term.
What are the three most commonly traded types of commodities?
Investors can invest in hard commodities (like metals), soft commodities derived from plants (like grains, coffee and cotton), or energy commodities (like oil, natural gas, and coal).
In 2019, energy commodities were the most traded by number of contracts, followed by agricultural commodities and then nonprecious metals, according to Statista. Precious metals like gold and silver are much more thinly traded. Crude oil is the most commonly traded single commodity.
What are commodity exchanges?
Commodity exchanges are marketplaces where materials or futures contracts are bought and sold. Physical trading locations, or pits, are in declining use amid the rise of electronic trading–as in most other financial markets.
In the U.S., the major commodity exchanges are the Chicago Mercantile Exchange Group (CME) and its subsidiaries the New York Mercantile Exchange (NYMEX) and the Chicago Board of Trade (CBOT), as well as the Intercontinental Exchange, which started as an energy exchange but also grew through acquisitions and now trades many types of commodities. Outside the U.S. some well known exchanges are the London Metals Exchange, Brazil's B3 and China's Zhengzhou Commodity Exchange.
How to invest in commodities
Investors can buy and sell physical commodities or futures contracts for commodities on a commodities exchange via their bank, a broker, or on trading apps. Traders can buy futures contracts or trade in the spot market, where actual goods are bought and sold. Investors participating in the spot market will incur fees related to storing and insuring physical commodities.
Investors can gain exposure to commodities by buying a number of financial securities.
- Futures. Futures are contracts to buy or sell a security on a given date. Investors can buy commodities futures contracts that don't actually require them to receive those physical commodities. Investing in futures can be attractive for small investors because they very likely don't have the space or proper facilities to store barrels of oil or a ton of corn.
- Stocks. Investors can buy shares of companies that extract or process commodities. For example, shares in oil and natural gas companies like Exxon tend to rise when energy prices rise and fall when energy prices fall. One can also invest in mining companies like BHP Billiton, livestock processors like JBS and food-processing companies like ArcherDanielsMidland.
- Exchange-traded products. One relatively new way to invest in commodities is through ETFs. Commodity ETFs, like the SPDR Gold Shares and iShares Gold Trust funds, may focus on a single commodity or may consist of a basket of commodities in the same way stock ETFs can be made of a basket of stocks.
- Mutual funds and index funds. Investors can buy funds invested in commodity-related companies, funds that use futures contracts, or a combination of both. Some funds will track a commodity index, which is a compilation of commodities much like a stock index is a collection of stocks.
Commodity investing vs. stock investing
Commodity markets are where physical goods like crude oil, corn, coffee, and gold, or futures contracts for commodities are bought and sold. Stock markets are where shares of corporations are bought and sold; no physical goods are traded.
In the U.S., stock markets are regulated by the Securities and Exchange Commission (SEC) while commodities markets are overseen by the Commodity Futures Trading Commission (CFTC).
While commodities are basic or raw materials that come from a natural resource, commodity stocks are shares of companies that have significant business in extracting, growing or processing those resources. Commodity-stock investors hope to see an increase in share price but can also benefit from dividends and company share-buyback programs.
Potential benefits and risks of commodities investing
- Potential benefits. Commodities can diversify a portfolio and can be a hedge against inflation. Gold is well-known as an inflation hedge. Investors may also find that making investment decisions based on watching weather and crop reports suits them better than reading earnings reports and livestreaming corporate announcements.
- Potential risks. Commodities may experience price swings due to unexpected global events. Bad weather that destroys crops, or livestock and crop diseases can quickly change commodity prices. The oil market can also change rapidly if the Organization of the Petroleum Exporting Countries (OPEC) and nonmember countries that often work with the cartel, like Russia, change policy. The prices of other commodities have their own specific factors weighing on them.
The bottom line
Commodities investing is a way for anyone from retail investors to giant corporations to participate in the market for valuable resources. Investors can buy or sell directly in the futures market or spot market, or they can put money into commodity ETFs, ETCs, or businesses with heavy exposure to commodities like oil producers, minerss, or food companies. However they invest, adding commodities to a portfolio provides exposure to the market for raw materials and can add portfolio diversification or serve as a hedge against inflation. Still, the commodities market itself can also be quite volatile.