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How to Invest in Commodities

There are five basic ways to invest in commodities. Here's how.

Futures Contracts

Futures contracts are mostly used by commercial and institutional investors with a need for the raw commodity. These legal agreements set terms for traders and sellers to exchange the goods for a predetermined price at a set point in time.

Q.ai says: Manufacturers and service providers rely on futures contracts to budget for the upcoming year, as well as to lock in prices before unfavorable fluctuations. Examples may include:

  • Fuel purchases in the airline sector
  • Food manufacturers pre-purchasing grains, coffee beans, or meat
  • Smelters ordering metals from a new mine

Speculative investors (advanced traders looking to profit from price changes) may also trade futures contracts. However, as they have no need for the goods, they usually close the contract before delivery. Another way investors may trade is with futures options, which gives the right but not the obligation to exercise their contract.

There are a few unique benefits to futures compared to other investments. For one, it’s easier to analyze your investment, as the terms are spelled out in your contract. Plus, you can take either long or short positions – which gives you the potential to see huge profits on little capital. In fact, due to the global interconnectedness of the market, it’s possible to see a futures contract double in a matter of seconds.

However, there are significant risks to consider. For instance, while a contract may see excessive gains, the inherent volatility of commodities markets means that your principal may also be wiped out in seconds. Furthermore, the minimum deposit clause on many futures contracts is contingent upon markets rising. Thus, if the market falls instead, an investor may no longer meet the minimum deposit requirement. In these cases, investors will either have to pony up additional cash – or see the contract closed out.

Commodity Pools

Another way to get started investing in commodities is to put funds into a commodity pool. In these arrangements, a CPO – commodity pool operator – gathers money from investors to buy a futures contract or option. CPOs must abide by certain regulations, such as:

  • Keeping detailed records
  • Providing annual financial reports
  • Giving investors access to quarterly account statements

Typically, a CPO employs a CTA (commodity trading advisor) to offer investing advice. These situations come with the advantage of having a licensed professional on hand to help manage investments. Plus, smaller investors with less capital can purchase a stake in larger contracts to seek larger gains.

ETFs, Notes, and Commodities

ETFs (exchange-traded funds) and ETNs (exchange-traded notes) are another commodity investing opportunity. Like stocks, these investments allow investors to profit from price fluctuations – without the risk of signing a futures contract.

When it comes to commodity ETFs, these funds track the price of a particular commodity or sector using futures contracts as their baseline. Others may back their fund by holding the commodity in storage.

On the other hand, ETNs are unsecured debt securities that mimic the fluctuation of a commodity or index. These investments are backed by the issuer. While they let investors participate in the commodities market without a special brokerage account, they do come with a higher credit risk.

Furthermore, while these investments trade like stocks, not every commodity has an ETF or ETN. And just because an underlying commodity moves, that doesn’t mean the fund will benefit from price changes.

Stocks and Commodities

More commonly, investors get involved with commodities markets by purchasing the stock of companies that engage in commodities production. For instance, energy investors may put their money into mining corporations or solar farms. Or people who are interested in agriculture may invest in farms or slaughterhouses.

One of the biggest advantages of stocks over futures options is that there is more information available. Plus, they’re more liquid, as you’re more likely to find an investor who wants to buy out your stock position (as well as a broker to facilitate your trades). Not to mention, stocks are less prone to volatility than futures contracts.

On the other hand, investing in commodities stocks is not the same as playing on the commodities market. Just because the price of gold does up doesn’t mean your preferred mining company will realize gains. Furthermore, there are plenty of company-related factors that may influence the price of a stock outside the global factors that influence the price of the physical commodity.

Mutual Funds and Commodities

Unlike commodities futures and stocks, mutual funds don’t directly invest in commodities. However, there are a handful of mutual funds that invest in:

  • Stocks from commodity-related industries
  • Commodities futures contracts
  • Commodity-linked derivatives and securities

Of course, this doesn’t mean that mutual funds are “safe” or risk-free; like all investments, there is a chance of losing your principal. Additionally, they tend to come with higher management fees and sales charges than ETFs, which can eat into potential profits.

Disclosures

Q.ai offers advisory services through Quantalytics Investment Advisors, LLC ("QIA"), a Registered Investment Adviser. This is solely for informational purposes. Advisory services are only offered to clients or prospective clients of QIA . Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. Comments by viewers or third-party rankings and recognitions are no guarantee of future investment outcomes and do not ensure that a client or prospective client will experience a higher level of performance or results. Adviser has reasonable belief that the content posted by a Third Party does not contain untrue statements of material fact or misleading information regarding its advisory services.

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