When I began learning about investing I often came across the word commodity and heard different specialists suggesting that people should invest in them. Here I explain what they are, some ways to invest in them and why you might want to consider it.

Commodities are basic goods that people use in their everyday lives such as grains, oil and gas. These goods are interchangeable with other goods of the same type, so prices are not affected by who produced them. Grains, for example, are pretty much the same regardless of who produced them. If a company uses wheat to produce crackers, for example, this company will have a variety of producers to choose from that offer a similar product. There is no branding or value added by a specific company.

Commodities are typically sorted into four categories: energy, livestock, metal and agricultural. Because those basic goods are subject to unpredictable factors such as the weather, pandemics, natural disasters and changes in supply and demand, they can be considered risky investments.

Trading commodities is not new and people have been trading them since ancient times. More recently people began to trade them in commodities exchanges and nowadays you have other options to invest in commodities, such as such as futures contracts, options, and exchange-traded funds (ETFs).

Why invest in commodities

If commodities can be considered a risky investment, as they are subject to unpredictable factors, why do people invest in them?

• Diversification – The prices of commodities tend to have a negative correlation with the stock market. Some investors like to have a position in commodities for when the market is more volatile.
• Hedge against inflation – When inflation is high the prices of commodities tend to go up. Just like the prices of goods and products in the supermarket tend to go up during those times.

How to invest in commodities

While manufacturers and other companies typically invest in commodities, there are also ways an individual investor can take a position. Some ways are more complex and riskier than others, and therefore less suitable to a beginning investor.

Here are some ways you can invest in commodities:

• Futures contracts and Options – These options allow the investor to buy or sell a commodity sell a commodity at a predetermined price at a specific time in the future. The main difference between the two is that with options the investor has the right to buy or sell at a specific price, while with future contracts there is an obligation to complete the transaction. There are future contracts available for every category of commodity and most also offer the option to purchase options. To invest in futures and options you need a broker that offer these options. Futures contracts is generally an investment done by companies and more sophisticated investors as it can be very risky. Options are less risky than futures contracts, but it is also an investment recommended for more sophisticated investors.
• Exchange Traded Funds ETF’s – ETF’s are funds that track the price of a commodity index usually by using futures contracts. These ETF’s trade like stocks.
• Stocks – You can take a position in commodities by buying stocks in companies that are related to that commodity. For example, if you want to invest in gold you can buy stocks in companies that mine this metal. If you prefer to invest in oil you might choose to buy stocks in a refinery or a drilling company.
• Mutual Funds – Mutual funds allow you to invest in stocks of companies related to different commodities industries. You can invest directly in commodities, but there are some commodity index mutual funds that provide different options for investors.
• Commodity pools – A commodity pool is a pool of money gathered from different investors in order to invest in futures contracts and options. These pools have to comply with a number of requirements and will usually rely on professional advice.

Some of the options above, like futures contracts, options and commodity pools are more complex and not recommended for every investor. The easiest way for an individual investor to take a position in commodities is through stocks, ETF’s and mutual funds. As always, make sure to check how much you will be paying in fees, especially if you choose to use mutual funds for your investment.

Are commodities part of your investment portfolio? How do you invest in them? Let me know in the comments below.