Things you need to know if you are investing in commodities

Australia is blessed with abundant natural resources. The extractive industries are key to the Australian economy and to its stock market. Many investors are naturally drawn to investing in commodities.

Definition of commodities

A commodity in an investment context is used to indicate any bulk goods that are traded on the local or the international maker. They are typically traded on an exchange or on the cash market. There are many types of commodities trades and they are usually very important for the global economy. Among the best known and most commonly traded commodities are crude oil, natural gas, grains, cattle, metals, and gold. There is a diverse range of commodities that can be traded.

How to trade commodities

Investors can invest in commodities either directly as in purchasing stocks in companies. For example, if you want to take advantage of rising oil prices why not invest in some multinational oil companies. In general, the value of the company’s shares is linked to the price of the commodity that they extract or trade.

Then it is possible to invest indirectly in commodities, by placing money in a funds. Now it is not feasible to purchase and store commodities. Although gold can be bought in the form of bullion or coins. There are a range of investment vehicles that allow investors to invest in commodities and indeed to purchase a considerable amount of some material such as grains. There are dedicated funds that allow investors to make a profit from the trade in commodities. Investors often place their money with fund managers and they invest that money in futures. These financial products are very popular with commodity investors. A future gives a fund manager the right to buy a product at a given price and to sell it at a certain price later. Typically, futures are usually settled for their cash value at some fixed period usually referred to as the maturity period. Fund managers make money for their investors if the future goes up in value. The value of the future is determined by the price of the commodity on the market. It should be noted that if the price goes down then a future loses value this can result in a loss for investors.

Pros and cons of commodity trading

There are some advantages to investing in commodity futures. They can deliver a high return and they can protect a portfolio against inflation. Moreover, they can help to diversify a portfolio. There are some disadvantages to this type of investment. Investing in commodities are rated as among the riskiest as they can fall in fall. Moreover, they are closely correlated to global trade flows and the economic cycle and they may not protect an investor during a slowdown or a recession.

Why to invest in commodities

In general, it may be a good idea to invest in commodities. This is because material such as gold and oil are finite. This means that as the world economy expands that there is a growing demand for commodities and in consequence, the price for items such as cattle and oil will inevitably increase. Then it is possible that the stock market has peaked, and this usually correlates to high returns for those invested in commodities.

Oil is expected to rise in the coming months and year, driven by economic growth and Iranian sanctions. Another good commodity to invest in is wheat and especially soybeans. The trade dispute between the US and China means that the price of soybeans could rise. Another commodity that could provide investors with a good return is cattle. The demand for meat is rising as many parts of the globe develop and adopt more western lifestyles. However gold, may not be as attractive as it once was. Once it was seen as a great hedge against inflation. As inflation has remained muted it has tended to depress the demand and hence the price of the precious metal.

It is important to accept that while commodities offer high returns they do carry a significant risk. Therefore, an investor needs to be very careful when investing either directly or indirectly in the commodity space. In general, indirect investing it less risky.