If you’ve been part of the investing community for any length of time, chances are, you’ve heard about commodities. These basic goods are essential to much of modern life – if you’ve ever eaten grain, driven a car, or slathered a slab of beef in steak sauce, then you’ve enjoyed the end results of the commodities markets.
But what are commodities in terms of investing?
Investors often speak of commodities as a way to diversify their portfolios outside of traditional investments. Some investors trade them regularly, but others may join only during times of market volatility to buffer against unwanted stock movements.
While bartering markets have been based on trading commodities for thousands of years, investors can purchase modern ones on exchanges (similar to securities). Nowadays, a commodities exchange may refer to both the legal entity that enforces the rules of trade, as well as the physical location where traders buy and sell the commodities.
There are two main types of commodities that you divide into four categories:
Unusually, all commodities are treated equally in their class. For instance, a cow is a cow, regardless of the ranch it comes from. Similarly, precious metals or oils are traded at the same value, even if they come from different mines or countries. This perception of uniformity is what makes commodities investable assets.
While investing in commodities used to be left to the professionals, modern technology has allowed for more individuals to trade in the big leagues.
Commodities markets are unusual in that they are governed by the “real world” version of supply and demand. This is a contrast to stock markets, where supply and demand is governed by investor interest and the issuing organizations. For example, the price of raw metals depends largely upon the need of countries with large manufacturing sectors, such as China.
As a result, supply and demand drives commodities markets, rather than traders’ whims. Thus, low supply means higher prices, while low demand drives prices down. But this doesn’t mean that commodities markets are always predictable. Issues such as global economic and political issues may impact the price of commodities. Additionally, natural disasters, pandemics, and even mine collapses may affect the price of a particular commodity.
There are five basic ways to invest in commodities:
We cover each of these more in depth to get a better understanding of their mechanisms, risks, and benefits here.
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