Five Ways to Invest in Commodities
The threat of inflation and the proliferation of investment instruments in this asset class are some of the factors that have enabled the popularity of commodities to grow.
iPath DJ-UBS Cotton ETN (BAL) has gained 77% this year and iShares Silver Trust (SLV) with a 70% gain is not far behind. However, there are some losers as well. United States Natural Gas (UNG) has lost as much as 40%.
With such a wide difference in performance within what seems to be a related group, investors need to understand the key factors that often tend to drive prices within each category. For this purpose, it is helpful to know how commodities are categorized.
This article describes the different categories of commodities and explains how their prices are impacted by different forces - global, national, and local. It also lists one preferred ETF in each category or sub-category and a diversified commodity ETF which are worthy of consideration.
Commodities can be classified into four broad categories: agriculture, energy, precious metals, and base metals.
Demand for various agricultural products is growing due to population growth and improving standards of living in emerging economies. Severe weather conditions like drought or excessive rainfall and flooding as well as outbreaks of pestilences can affect the supply of agricultural commodities.
PowerShares DB Agriculture (DBA) is a preferred agriculture play. It invests in cattle feeder, cocoa, coffee, corn, cotton, lean hogs, live cattle, soybeans, sugar, and wheat.
Energy commodities fall into three sub-categories: crude oil, natural gas, and refined products like gasoline and heating oil. Crude oil is an international commodity and its price is impacted by global supply and demand imbalances oftentimes caused by geo-forces. Natural gas is generally a domestic commodity and its demand can be impacted by a nation's economic health and energy policies.
Demand for refined products like gasoline is mainly driven by local industrial activity. Product specifications and availability of refining capacity are among the factors that impact supply of refined products. Temporary supply disruptions may also be caused by severe weather phenomena like hurricanes.
PowerShares DB Energy (DBE) is a preferred energy play. It invests in a basket of energy commodities including crude oil, heating oil, gasoline and natural gas. Investor looking for focused exposure to crude oil and natural gas can consider crude oil futures trading ETF PowerShares DB Oil Fund (DBO) and natural gas futures trading ETF United States Natural Gas (UNG), respectively.
Precious metals like gold and silver appeal as an inflation hedge as well as a safe-haven against financial or political turmoil. Prices of precious metals often move with little or no correlation to the stock market. Therefore, investors tend to include precious metals to diversify, and manage the risk in, their investment portfolios.
Base metals like aluminum, copper, zinc and alloys like steel are extensively used in industrial goods and in construction. Their prices are impacted by the level of economic activity. China has emerged as a global manufacturing hub. China is building its stockpile of base metals for their strategic reasons. The twin forces of economic sensitivity and 'strategic value', have lent to base metals the characteristics of both energy commodities and precious metals.
Investors seeking exposure to base metals can look to PowerShares DB Base Metals (DBB) that invests in aluminum, copper, and zinc.
For investors seeking one diversified ETF, PowerShares DB Commodity Index Tracking Fund (DBC) provides exposure to 14 commodities including agricultural commodities, energy commodities, precious metals, and industrial metals.
Investors need to plan their commodity trading strategies to earn the best returns and avert disappointments.
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