How to Invest in Commodities

Adding commodities to a portfolio, either through physical ownership or investment brokers, provides diversification and can even offer a hedge against price exposure further up the value chain of certain industries. Energy products like oil, gas, and coal; agricultural products like corn, soy, canola, pork, and beef; and metals like gold, silver, copper, and platinum all have well understood market dynamics and relatively simple financial instruments to act as trading vehicles. Many commodities are priced according to the market demand and the need for further processing. In a world where many financial assets are derivatives, trackers, and derivatives of derivatives, with layers of market sentiment influencing their performance, commodities can offer a more direct experience. We will take a look at the major commodities and how you can use them to fit your investment needs. 

How to Invest in Commodities

Investors can access commodities in a few different ways.

Physical Ownership

Owning physical commodities mainly applies to precious metals. Gold and silver are two of the best-known commodities that are used as physical stores of value. Investors can purchase these metals formed into bullion, with standard size and purity. Bullion bars are the closest in value to the melt price (the market price for the metal if you melted it down). Owning precious metals in physical form comes with issues of storage, insurance, and liquidity. Commodities beyond precious metals have further storage issues in that the quantities are often larger and there is a shelf life, so they must be sold within a given timeframe. This is why most commodities investors do not pursue physical ownership. To trade physical commodities, you need to find a reputable dealer and, most likely, a storage facility for your holdings. 

Futures Contracts

Futures contracts are direct plays on commodity prices. Futures contracts are an agreement to buy or sell a specified amount of a commodity at a specified price and date in the future. Investors use leveraged margin accounts to allow them to take larger positions with their existing capital. In the vast majority of trades, the contracts are cash settled. This saves an investor from having to take delivery of hundreds of thousands of pounds of sugar or figure out how to market a thousand head of cattle. Opening an account to trade futures contracts will often require some additional paperwork to enable margin trading as well as a higher account minimum. The specific maintenance margin needed in an account varies with the value of the contract being traded. 

Individual Securities

Individual securities related to commodity processing or production can be accessed through a regular brokerage account. You can find the companies using a stock screener and looking for basic materials or energy sector companies. Investors looking for commodity exposure through company shares generally have to gain some industry-specific knowledge to be successful. For example, extraction companies in mining and energy have well-developed systems for feasibility studies on reserves that, in turn, drive the stock value. Larger companies will have reserves in different parts of the world and in different stages of development, meaning the impact of any one feasibility study is not a big deal as long as overall operations are profitable. A smaller company, however, may experience heightened price volatility based on the findings of a single feasibility study.  

Mutual Funds, Exchange Traded Funds (ETFs), and Exchange-Traded Notes (ETNs)

Products traded on exchanges include commodity-based mutual funds, ETFs, and exchange-traded notes, which can provide exposure to commodities. There are exchange-traded products that are specific to individual commodities. These pool investor funds to combine capital in a commodity pool. The actual mechanism for investment depends on what is outlined by the fund. The fund managers could buy futures, options on futures, shares in companies in the sector, or even purchase and store physical goods. Some funds are leveraged, meaning they are attempting to provide double or triple the price movement of the commodity they are tracking. This is why it is important to read the fund disclosures prior to investing to ensure the exposure being offered matches your investment needs.  

Alternative Investments

Commodities are considered an alternative investment along with things like real estate that don’t trade in the conventional style of stocks and bonds. Within precious metals, however, there is a subcategory of alternative investments that are closer to collectibles than they are to investments. Bullion coins and jewelry have an aesthetic and historical value that generally sees them trade at a premium compared to the melt price of the metals they contain. While these are still physical investments that can appreciate in value, their prices are less connected to market prices. You can buy jewelry from stores and coins directly from the Mint or from dealers, but they are more of a collectible than they are a commodity investment.    

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What Do You Need to Open a Commodities Investing Account?

Opening a commodities investing account is the same process as opening a regular brokerage account. If you are just looking to invest in commodities through companies and funds, it literally is a regular brokerage account as these two investment classes do not require anything special. If you will be trading futures and options, however, you first need to confirm your broker provides these options. Then you will usually have to make some additional disclosures to ensure you understand the risks and have enough capital so that it will not be wiped out in a single trade. 

What You Need to Open a Brokerage Account 

To open a brokerage account, you need to provide some personal and financial information and  answer some basic questions. 

Personal Information

The personal and financial information includes:

• Name, address, and telephone number
• Tax identification number (usually your Social Security number)
• Date of birth and government ID 
• Banking information for funding the account
• Level of investment experience and risk tolerance (the know your client (KYC) questions)

With online brokerages, the first step is usually to set up an account (email and password) with the broker and then provide these further details as part of the onboarding process. 

Minimum Deposits

While there are many brokerage accounts with zero account minimums, enabling futures trading in a margin account will generally require that at least a few thousand dollars be held with the broker. Depending on the contracts you are looking to trade, the actual amount of capital required to trade will be more than whatever the minimum deposit is to enable the account. Both the initial margin and the maintenance margin for futures accounts may be influenced by the account type (individual retirement account vs. non-IRA account). 

What You Need to Open a Gold IRA

Gold individual retirement accounts (gold IRAs) are a type of commodity investing for retirement purposes. Unlike a regular IRA, you will have to find a custodian to hold the physical assets. You set up a gold IRA by first establishing a self-directed IRA, selecting a custodian to administer the account, selecting an approved depository to hold the gold, and then choosing a broker/dealer to buy the gold through. Some gold IRA providers have these services integrated or will refer clients to providers in their network.

Personal Information

The documents and information required are the same as those for investment accounts:

• Name, address, and telephone number
• Tax identification number (usually your Social Security number)
• Date of birth and government ID 
• Additional KYC questions 

Minimum Deposits

Minimum deposits for a gold IRA are high. This is partially owing to the fact that an ounce of gold is worth over $1000 and even smaller coins are worth several hundred dollars. The IRS rules state that only approved coins and bars of gold can be used for a gold IRA, but they do not set a minimum. While not all gold IRAs advertise a minimum, a practical amount would be at least $2000. Other gold IRAs have minimums of $10,000, $25,000, and even $60,000. 

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Pros and Cons of Commodity Investing

Commodity investing, like any other type of investing, comes with advantages and disadvantages. 

Pros

Investors are attracted to commodity investing for its ability to provide an inflation hedge, diversify a portfolio, and unlock potentially large returns. 

• Inflation hedge: The prices of commodities tend to rise with inflation. In fact, commodity prices are often watched as indicators of an inflationary environment. While there can be commodity-specific market conditions that counter overall inflation, such as a bumper crop, in general commodities move with inflation and can balance out the dampening effect that inflation may have on other assets in an investor’s portfolio. 
• Diversification: Even outside of an inflationary environment, commodities provide portfolio diversification due to a low correlation with financial assets. Commodities are influenced more by basic factors like supply and demand rather than employment numbers or central bank policies.
• Potential for large returns: Commodities like oil, gold, and soft commodities with cyclical production can experience large price movements. Commodities are sensitive to production forecasts and global events that impact supply chains. These opportunities for profit are what attracts investors to the commodities market. 

Cons

The downsides to commodity investing are a lack of income, high volatility, and external risks. 

• Lack of income: Investing in commodities doesn’t generate yield income like a bond or a dividend-paying stock. All of the return on a commodities investment depends on correctly predicting the price movements. 
• High volatility: Commodities can see their market dynamics shift wildly based on global events. Wheat prices, for example, shot up in 2022 due to the Russian invasion of Ukraine, and this price movement impacted the futures and options market around wheat. There were similar impacts in the oil and gas markets due to Russia’s position as a major supplier, but these were not quite as sharp. 
• External risks: When it comes to commodities, there are many risks that an investor simply has no control over. In addition to regional conflicts taking supply offline, there are climate risks with the wrong weather at the wrong time, regulatory risks and political risks that can hinder the flow of goods, supply chain risks, and so on. All of these risks are, of course, the main reason for the volatility and the opportunity for large returns. 

Factors to Consider When Opening an Investment Account

Commodities investing is not available through every broker. This is especially true for digital investment managers that limit their investing to ETFs and stocks. Larger brokers and trading-focused platforms generally do offer futures trading. This includes brokers like Schwab, Interactive Brokers, and E*TRADE, as well as more focused platforms like NinjaTrader and TradeStation. Below are the main factors to consider when opening an investment account for commodities trading. 

Customer Support

Customer support can vary widely between brokers. Most brokers still offer phone and email support, while some have added in-platform chat and social media channels for customers to reach them. A handful of brokers have gone the other way, with digital-only customer service offerings via FAQs and email contact forms. When it comes to customer service, you want to make sure the broker can be reached via your preferred method. 

Fees

Fees have become much more competitive for stocks and ETFs, with most brokers charging nothing at all. When it comes to futures, however, fees are calculated on a per-contract basis and can vary from mere cents to a few dollars. While the temptation is to find the lowest fee broker for futures, it is important to consider it in the context of the quality of the overall trading platform. 

Available Assets

While most brokers offer both ETFs and stocks, futures is more of a niche offering. If you are looking to invest in commodities, you are probably going to want access to the major futures exchanges unless you plan on solely working through ETFs. 

Security and Reputation

Generally speaking, you want to know that your broker is keeping your portfolio safe and has your best interests at heart. At a minimum, you want to see security protocols that are up to industry standards with two-factor authentication and plans in place to prevent outages and data breaches. 

Minimum Deposit

Overall we like to see brokers with low minimum deposits to encourage people to invest. When it comes to futures, however, an investor should have a sizable amount of capital both to enable the margin account and ensure they can handle potential swings without devastating their portfolios. Commodities investing is definitely a risk capital activity and shouldn’t make up the majority of your investment portfolio. 

Research Tools

Research tools can be important in helping you understand and visualize market dynamics when investing in commodities. Robust trading platforms can help by pulling quotes into charts and analyzing volume and volatility along with other important information like headlines and calendar events. Some brokers charge for extra data feeds, but this is another area where competition has lowered the overall costs. 

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