Top 5 Ways to Invest in Commodities

Basics

Enhancing portfolio diversity involves integrating commodities, a move that ensures diversification and functions as a safeguard against potential price exposure higher up the value chain in specific sectors. Energy commodities such as oil, gas, and coal, alongside agricultural staples like corn, soy, canola, pork, and beef, as well as metals such as gold, silver, copper, and platinum, exhibit clear market dynamics. They are associated with relatively straightforward financial instruments suitable for trading activities. Unlike many financial assets entangled in derivatives and layers of market sentiment, commodities offer a more direct investment experience. This analysis delves into key commodities, exploring how to tailor their inclusion to meet your investment objectives.

Top 5 Ways to Invest in Commodities

Investing in commodities presents diverse pathways for investors to explore.

Physical Holdings

Primarily relevant to precious metals, physical ownership involves acquiring gold and silver in bullion form, standardized in size and purity. However, storage, insurance, and liquidity challenges accompany precious metal ownership. Non-precious commodities exacerbate these issues due to larger quantities and shelf-life constraints.

Futures Contracts

Offering direct exposure to commodity prices, futures contracts entail agreements to buy or sell a specified amount at a predetermined price and date. Leverage through margin accounts allows investors to magnify their positions. Most contracts are cash-settled, eliminating the need for physical delivery.

Individual Securities

Companies engaged in commodity processing or production can be accessed through regular brokerage accounts. Identifying relevant companies through stock screeners, especially in the basic materials or energy sectors, requires industry-specific knowledge for successful investment.

Mutual Funds, ETFs, and ETNs

Traded on exchanges, these products pool investor funds for commodity exposure. Fund mechanisms vary, ranging from futures and options to shares in sector companies or physical goods. Leverage is present in some funds, necessitating careful scrutiny of fund disclosures.

Alternative Investments

Commodities, categorized alongside non-traditional assets like real estate, deviate from conventional stock and bond trading. Within precious metals, a subset of alternative investments, such as bullion coins and jewelry, resembles collectibles more than investments, trading at a premium based on aesthetic and historical value. These items, though physical investments, are more akin to collectibles than traditional commodity investments.

Requirements for Commencing Commodities Investment Accounts

To start a commodities investing account, you have to follow the same procedure as for establishing a regular brokerage account. If you are only interested in commodities through companies and funds, then a conventional brokerage account is all you need, as these investment categories have no unique requirements. However, if you plan to delve into futures and options trading, you must make sure your broker supports these instruments. In such cases, you will also need to provide additional disclosures to acknowledge the associated risks and confirm that you have enough funds to avoid potential losses in a single trade.

Requirements for Brokerage Account Opening

Initiating a brokerage account necessitates the provision of personal and financial details, coupled with responses to fundamental inquiries.

Personal Details

• Name, address, and telephone number
• Tax identification number (typically, your Social Security number)
• Date of birth and government ID
• Banking particulars for account funding
• Level of investment experience and risk tolerance (addressed through knowing your client (KYC) questions)

For online brokerages, the initial step generally involves setting up an account (email and password) with the broker, followed by the submission of these additional details during the onboarding process.

Minimum Deposits

While numerous brokerage accounts have zero account minimums, engaging in futures trading within a margin account typically mandates holding a few thousand dollars with the broker. The actual capital required for trading, depending on the targeted contracts, often surpasses the minimum deposit necessary for account activation. The initial and maintenance margins for futures accounts may be influenced by the account type (individual retirement account vs. non-IRA account).

Requirements for Opening a Gold IRA

Gold Individual Retirement Accounts (Gold IRAs) are a form of retirement-focused commodity investment. Differing from regular IRAs, a custodian is essential to safeguard the physical assets. The establishment of a gold IRA involves creating a self-directed IRA, selecting a custodian, choosing an approved depository for gold storage, and opting for a broker/dealer for gold acquisition. Some providers integrate these services, while others guide clients to affiliated providers.

Personal Details

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

Minimum Deposits

Gold IRA minimum deposits are relatively high due to the substantial value of gold, with an ounce exceeding $1000. IRS rules mandate approved coins and bars for Gold IRAs without specifying a minimum. While not universally advertised, a practical minimum ranges from $2000, with certain Gold IRAs imposing minimums of $10,000, $25,000, or even $60,000.

Exploring the Advantages and Drawbacks of Commodity Investments

Commodity investments, akin to other investment types, present both favorable and unfavorable aspects.

Pros

• Inflation Hedge: Commodities, often viewed as indicators of inflation, tend to rise with inflation, offering a hedge against its impact on portfolios.
• Diversification: Beyond inflation, commodities provide portfolio diversification due to their low correlation with financial assets, being influenced more by supply and demand factors.
• Potential for High Returns: Cyclical production in commodities like oil, gold, and soft commodities can lead to significant price movements, offering profit opportunities driven by production forecasts and global events.

Cons

• Lack of Income: Unlike bonds or dividend-paying stocks, commodity investments lack yield income, relying entirely on accurate price movement predictions.
• High Volatility: Global events can cause erratic market dynamics in commodities, exemplified by sharp increases in wheat prices during the 2022 Russian invasion of Ukraine and similar impacts in the oil and gas markets.
• External Risks: Commodities entail uncontrollable risks, including regional conflicts affecting supply, climate, regulatory, and political risks disrupting the flow of goods, contributing to volatility and potential returns.

Important Considerations Before Opening an Investment Account

When contemplating the initiation of a commodities investment account, it's crucial to recognize that not all brokers facilitate commodities investing. Digital investment managers, focused solely on ETFs and stocks, often lack this offering. Larger brokers and trading-focused platforms, such as Schwab, Interactive Brokers, and E*TRADE, provide futures trading opportunities. Key factors to assess when opening an investment account for commodities trading include:

• Customer Support: Brokerage customer support varies, ranging from traditional phone and email options to in-platform chat and social media channels. Ensure the broker's support aligns with your preferred communication method.
• Fees: While stocks and ETF fees have become competitive, futures trading fees, calculated per contract, can vary significantly. Balance the appeal of low fees with the overall quality of the trading platform.
• Available Assets: Commodities, mainly through futures, are niche offerings. Confirm that the broker provides access to significant futures exchanges if you intend to invest in commodities directly.
• Security and Reputation: Prioritize brokers with robust security protocols, including two-factor authentication, and a solid reputation for safeguarding portfolios.
• Minimum Deposit: While low minimum deposits are generally favorable, for futures trading, a substantial capital amount is advisable to enable margin accounts and withstand potential portfolio swings.
• Research Tools: Evaluate the research tools offered by brokers to comprehend and visualize market dynamics in commodities investing. Robust trading platforms with features like charting, volume analysis, and headline tracking can enhance decision-making.

Popular Commodities for Investment

Several highly traded commodities encompass:

• Precious metals (gold, silver, platinum, etc.)
• Oil
• Natural gas
• Gasoline
• Corn
• Wheat
• Soybeans
• Cattle
• Hogs
• Sugar
• Lumber

It's essential to recognize that futures trading volume is predominantly driven by financial assets, such as equity index, interest rates, and currencies, surpassing that of agriculture, energy, or metals.

How Leveraged Commodity ETFs Work

Leveraged commodity funds trade as fund shares, categorized as bull or bear funds, denoting their market position. In contrast, to direct futures or options positions, investors in these funds acquire shares, allowing the fund to engage in direct and indirect trades related to the underlying commodity using its available capital. For instance, a leveraged oil fund might hold futures, options, shares, and financial instruments like contracts for difference (CFD), striving to deliver a multiple of the reference index's performance. In essence, a leveraged oil fund with a two times multiplier seeks to mirror twice the short-term price change in West Texas Intermediate Crude Oil (WTI).

Conclusion

Integrating commodities into a diversified portfolio hedge against inflation and diversifies risk exposure. Energy, agriculture, and metals offer straightforward trading instruments, providing a direct investment experience. This analysis explores diverse investment avenues, emphasizing considerations for opening traditional and specialized accounts. As investors navigate the complexities of commodities, a strategic approach balances potential returns with inherent challenges, unlocking opportunities in this dynamic market.