How To Invest In Commodities as an Average Investor

by Silicon Valley Blogger on 2010-04-186

Commodity market prices can serve as an inflation indicator (via a commodity market index). If you’re looking for an inflation hedge, you may want to look at investing in this market.

One of the funnier stories on investment trading that I’ve come across is this one about the hapless commodities trader.

It was that moment that Brad’s palm almost immediately made contact with his forehead. He realized that something must have really gone awry: instead of virtually trading 28,000 tons of coal, Brad had somehow ended up with 28,000 tons of real coal.

The point here is made clear: when it comes to your money, don’t get too overconfident….. or stupid.

But this story shouldn’t scare you away from making trades or investing in (what seems to be like) more esoteric markets. If you’re interested in truly diversifying your portfolio and pursuing stock market diversification in earnest, then look into other asset classes, particularly those that don’t correlate as much to the standard investments you already own. In fact, our earlier story seems like a good segue into exploring the idea of investing in commodities a little further, especially as it relates to the average investor. While I’m not an expert in this area, it’s one aspect of investing that I’ve been curious about, given the diversification angle.

how to invest in commodities

The Commodities Market

The commodities market is actually a collection of 48 worldwide markets that trade 96 commodities. Everything from silver to orange juice concentrate can be sold. The largest market here in the United States is located in Chicago. Smaller in size and fame, the Chicago Mercantile Exchange or CME trades in a large amount of commodities.

Before we can talk any more about this market, we have to know what a commodity is. A gold bar, a barrel of oil, a pig, a brick of orange juice concentrate, and wheat are all examples of commodities. The two that tend to be the largest overall market movers are oil and gold. When there’s uncertainty in the air and investors become fearful about the economy and major investment markets, we often hear of them flocking to and investing in gold because as a commodity, it’s inflation proof as a tangible asset.

The CME isn’t a glorified grocery store, though. Farmers don’t show up in semis full of soybeans. Instead, the commodities market deals with futures contracts. A futures contract is simply an agreement to buy a commodity at some point in the future at a price dictated today. But as explained in this Q & A, it’s a zero sum game, and a “stunningly fast way to lose money”. While this is certainly one way to get involved with commodities, this is not the recommended way for small investors to go.

How To Invest In Commodities? Some Pointers For The Average Investor

How does the average investor play the commodities market? Well it’s a different story to trade vs invest in an asset. In this case, using commodities as a way to round out a diversified portfolio may actually be a reasonable strategy. There are many ways to invest in commodities, ranging from the simple to the complicated, but the easiest way is through an ETF (here’s more on ETF investing basics).

Here are a few examples:

The SPDR Gold ETF (GLD) is one of the most useful commodity ETFs on the market. This fund is currently the 6th largest holder of actual gold. Investors regard GLD as a great hedge against downturns. So you may want to have this in your portfolio to help balance things out when the overall stock market goes down.

PowerShares has a sugar, corn, soybean, and wheat ETF (called the PowerShares DB Agriculture Fund with symbol: DBA). The ETF tracks the performance of these four commodities, so when prices of these commodities go up, so does the ETF.

Now you can also decide to get directly involved in futures contracts but in general, that should only be for the serious, full time investor. The last thing you want is a truckload of corn showing up at the doorstep of your apartment (as per our introductory story earlier 😉 ).

For more information, you can check out your online stock broker for the list of ETFs they have available for purchase. And for a more in depth coverage and analysis of commodity investing, check out this link.

Copyright © 2010 The Digerati Life. All Rights Reserved.

{ 6 comments… read them below or add one }

The Biz of Life April 18, 2010 at 5:04 pm

There’s also ETFs such as Powershares DB Commodity Index Tracking Fund (DBC), iShares S&P GSCI(R) Commodity-Indexed Trust (GSG), iShares Silver Trust (SLV), as well as other ETFs that track the price of oil, natural gas, palladium, platinum, etc. ETNs are worth a look also, if you don’t mind the counterparty risk, such as the Rogers Indexes from Elements. PIMCO has a commodities mutual fund too.

Commodities don’t have a great track record of long term performance, and don’t compound interest or dividends, but they do tend to have low correlation to movements of the stock market. If you believe in scarcity, in increased third world demand, and that oil production has peaked, they might be worth a play.

Andy @ FirstFound April 19, 2010 at 2:59 am

Thanks for all the advice. I’ve always been slightly apprehensive of commodities, but you’ve demystified some of this for me.

basicmoneytips April 19, 2010 at 4:21 am

Personally I think gold is pretty high right now, but oil will almost certainly continue to climb. While we (the world) is trying to find alternative entergy sources, these sources fail to be a significant player in fulfulling the world’s energy needs. I think oil will do nothing but go up.

Really the article seems to be steering the investor to EFTs that deal in commodities. This is probably fine for the average investor.

Brandon Schmid April 19, 2010 at 6:10 am

I think for people to be able to invest in commodities they would first need an understanding of how to invest in the market as a whole.

Stock trading can get quite complicated very quickly and if some people don’t even know what a stop-loss is they might get into trouble.

At any rate, I do believe in commodities. I like the simple fact that most commodities are based on supply and demand and that is something that you can track and measure.



Brad April 20, 2010 at 2:30 am

I think I tried the commodities market once years ago but was terrified by how volatile the trading is – I’m not the Brad in the story! Investing thru ETF’s has less volatility – but still risky….

Brad 🙂

kennenlernen April 20, 2010 at 3:26 am

I believe EFTs are rip offs. I would rather just buy physical gold than gold EFTs. Someone will want their percentage when the price goes up. Not like that when you own it physically.

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