Commodity Investment 101

By Kevin Skaggs

Commodity investing may sound risky, but there are benefits to including commodities in your investment strategy. Agricultural products, oil and gas, and precious metals are just a few of the popular commodities that industry leaders have considered safe investments, but over time, these have all seen extreme ups and downs.

Supply and demand typically drives the prices for commodities, particularly agricultural products and oil, and this can make them a safer bet than filling your portfolio with stocks that can be all over the market.

Considerations for making commodity investing safer

Investing in commodities can be made safer and less volatile when an individual considers an exchange traded fund (ETF) that mixes both shares of the commodity itself and shares of the company or companies that provide the commodity.

Another consideration to make commodities trading safer for the investor is to set a limit on the amount of a specific commodity you will have in your portfolio. For example, advisors typically tell investors to dedicate no more than 10 percent of their investment portfolios to gold and other precious metals.

In another example of how commodities might be more stable than other stocks, the price of one type of commodity is not tied to the price of another. For example, the price of corn is not tied to the price of silver; if silver’s value drops, the price of corn remains the same.

Although commodities trading can be affected by large swings in prices and value, it is somewhat more stable than investing in a specific company. A commodity’s value is not dependent on an outside factor, like corporate earnings or a turn in public sentiment. This makes commodity investing slightly safer for investors; vegetables cannot be accused of inappropriate actions that lead to their values declining.

The future of commodity investing

For companies looking to diversify their portfolios, commodity investment can be a smart choice. Creating a diverse portfolio is not about selecting many different stocks to invest in; it is about choosing many different markets or asset classes. You want your investments to be as unrelated as possible to ensure that, if a portion of your investments goes poorly, the whole portfolio won’t suffer.

The most interesting thing about investing in commodities is that they are the only asset class that is negatively correlated to stocks and bonds, meaning that if stocks are going downhill, commodities are going up. Because of this fact, investing in commodities can offset the risk of investing in stocks and bonds; still, investing more than 5 percent of your portfolio in commodities is not recommended.

Because investing in commodities themselves doesn’t usually turn a profit, one of the most popular commodity investment techniques involves the use of futures contracts. Futures are the financial obligation that a buyer or seller has to purchase or sell an asset at a predetermined future price and date. You can buy and sell futures contracts in an attempt to turn a profit by going long or going short. If you choose to buy long, you are anticipating a rise in the prices. If you buy short you are expecting prices to decline. That being said, commodities investment is often risky and may not yield worthwhile results for the average investor.

For large companies, using commodities investment to hedge a risk can be beneficial, but for someone investing small amounts, the possible gains in the commodities market are not enough to offset the risks. Further, because of the recent slowdown in global economic growth, commodities have seen a sharp drop in profits, and most investors have seen a negative return. Unless the Federal Reserve figures out how to stimulate economic growth, China manages to create a soft landing, and Europe finds a solution to its sovereign debt crisis, the outlook on commodities will continue to be bleak.

Image credit: Flickr/Crashworks

Kevin Skaggs is a project manger for UK Universal Group. UK was founded based on a unique philosophy of skilled co-operation between founder Groups. UK Universal Group investors enjoy a culture that is best communicated through our success in meeting our client’s demands. Skaggs has helped to share UK Universal Group's knowledge about commodity investment with potential investors. UK Universal Group hopes that sharing their knowledge will educate people on the growing field of commodity investment.