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How to Invest in Commodities

While most people may think stocks and bonds are the only investment options, but if you’re learning how to invest in commodities you may know that they provide an option to diversify a portfolio.

Though most people are familiar with buying physical gold or other precious metals, today’s market offers a variety of options from exchange-traded funds (ETFs) to futures contracts.

What are commodities?

Commodities are basic goods that can be substituted with other equivalent goods of the same variety. These include:

  • Precious metals, such as gold and silver
  • Energy such as crude oil and natural gas
  • Industrial metals such as copper and tin
  • Food products including wheat and cattle

Commodity products become so homogenous between suppliers that though there may be slight differences in quality, the products mainly differentiate on price. Most commodities are priced in dollars, which allows some of them to be used as a hedge by investors.

The graph below shows how there is generally an inverse relationship between the U.S. dollar and the gold and oil commodities. Some commodities differentiate based on from where they’re supplied, such as West Texas Crude vs. London Brent Crude. Commodities also play into inflation as they are direct input costs for many industries and uses, such as steel for buildings and gas for cars.

As the cost of commodities rise, consumers spend more money to buy the same amount of the commodity, leaving them with less to purchase other goods and services.

Steps to invest in commodities

Investing in commodities can be done in a few simple steps.

1. Decide on the type of investment.

Investing in commodities can be done through several options:

Each type of investment vehicle has different risk, transaction, margin requirements, and contract parameters. Futures contracts require margin and carry additional risk compared to what you might find in an ETF.

Additionally, futures-based products have what’s known as backwardation and contango, where the current prices may have a discount or premium relative to the expected spot price in the future. This chart depicts how these concepts play out.

2. Determine the size of your investment

Figure out how much money you want to allocate to the investment and then determine how much of the investment you will be purchasing based on the price plus any fees associated with that particular commodity and investment vehicle.

Keep in mind that leveraged products, such as futures or leveraged funds, will move more than a regularly traded index and won’t need as much capital to achieve similar returns. However, because of the borrowing costs of leverage, they will provide lower returns on a comparable basis.

3. Choose the right brokerage

Depending on the type of investment and vehicle you choose you may be required to open a futures or stock account. Most major brokers from Fidelity to Schwab allow for the trading of stocks, ETFs and mutual funds within the same account.

Futures accounts will require additional setup and are not offered by all brokers. When purchasing physical assets there are separate dealers who buy and sell commodities. Need help selecting the best brokerage account for you? Visit Benzinga’s picks for the Best Online Brokerage.

4. Purchase the commodity

Once you have the correct account set up with the broker you can transact online, over the phone, or through one of their remote offices.  Commodity ETFs, mutual funds, and commodity supplier companies all trade and act like regular stocks.

Futures require a specific exercise date, as well as choosing between various-sized lots. Physical commodity brokers may have different requirements that are different from broker to broker that are similar to purchasing any other physical good.

Final thoughts

Commodities offer a unique way to invest in assets other than stocks. Though prices on commodities can be relatively stable for long periods of time, technological advances like fracking for oil can cause quick changes in the price of a commodity. Additionally, commodities can be influenced by natural events and supply disruptions.

Want to learn more about commodities trading? Check out Benzinga’s guides to the best futures brokers, the best commodity ETFs and how to invest in oil.

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