Investing in commodities is an appealing option for diversifying your investment portfolio and profiting from price movements in the global economy. This type of investment can add a layer of security if the stock market fluctuates since commodity prices tend to increase when stocks drop. However, it’s essential to understand the basics and consider several factors before venturing into commodity investments since they have a reputation for being risky and complicated.
Commodities are raw materials—most of which are from natural resources—used to make the production of consumer goods like food or clothing. Generally, there are two types of commodities; hard and soft commodities.
Hard commodities are natural resources mined or extracted, such as natural gas and coal, crude oil, rubber, and precious metals like copper, silver, and gold. Meanwhile, soft commodities refer to agricultural products that are grown or harvested, including but not limited to wheat, corn, soybeans, coffee, and cotton.
As basic goods, commodities of the same quality grade are often interchangeable. For instance, a drum of coffee that meets a certain standard will be put in the same category as any other drum of coffee that meets the same standard—regardless of the producer.
Why Investing in Commodities?
Investing in commodities can protect you against inflation as their returns tend to increase with high inflation. Vanguard’s research in 2021, utilizing the Bloomberg Commodity Index, reveals that a 1% unexpected increase in inflation would result in commodities rising by approximately 7% to 9%.
That’s why commodity investment is excellent for diversifying your portfolio beyond traditional assets like stocks or bonds. Diversifying your portfolio with commodities investment can help to maximize returns.
Despite market fluctuations influenced by factors such as interest rates, exchange rates, and the global economy, there is robust global demand for commodities. This favourable condition generally benefits companies specializing in commodities, potentially resulting in positive returns for investors.
There are plenty of methods to choose should you decide to invest in commodities. These methods have varying levels of complexity, ranging from owning physical commodities to simply buying ETFs that concentrate on commodities.
Owning physical commodities is the most basic way to make commodities investments. Although some of them can be impractical (like oil or cotton), transportable assets like precious metals are suitable for those wanting to own the metals. You can purchase them through pawn shops or online dealers. Meanwhile, ownership of commodities like cotton bales or rubber is more suitable for those involved in producing finished goods using those materials.
Similar to stocks, you can buy and sell commodities in bulk on exchanges. One method for doing so is by utilizing future contracts. Futures are financial contracts derived from commodities that bind parties to buy or sell them at a predetermined future date and price. Financial losses may occur if what you pay for future contracts is higher than the spot price at contract expiration.
If owning physical commodities doesn’t fit your liking, you can still invest in commodity stocks through exchange-traded funds (ETFs). These stocks come from companies that process or produce certain commodities. Since they are traded like stocks, ETFs offer convenient trading, provide diversification, don’t involve margin trading like futures, and generally have low expense ratios.
Important Things to Consider
Like other types of investments, diversifying your commodities portfolio is essential to maximize potential returns. You need to invest across different commodities to diversify well, which will diversify your overall investment portfolio. For example, you can own physical gold and invest in commodities ETFs. Check Bursa Malaysia to find what commodities ETFs are available for investment.
However, keep in mind that commodity prices are volatile since the commodity industry is influenced by external factors such as the global economy and exchange rates. Considering this condition, investing in commodities is more suitable for a long-term investment strategy. More importantly, check if your commodity trading platforms are safe. Make sure they have been licensed and regulated by Securities Commission Malaysia.
Investing in commodities can be a great addition to diversifying your portfolio. This type of investment offers protection against inflation as well as different methods to invest. However, commodities have risks like any investment, as their prices can be volatile. Besides, many factors like economic conditions and import controls can significantly affect the commodities industry, impacting the commodity prices and decreasing your investment value.
So before you start investing in commodities, it’s essential to learn about the potential risks and returns of each approach so that you can choose commodities that will work best for your investment portfolio.