Why and How to Invest in Commodities | U.S. Bank (2024)

Key takeaways

  • Commodity prices often follow inflation, which makes them appealing to investors looking to diversify their portfolios. However, returns on commodities can be unpredictable.

  • There are many ways to invest in commodities, from physical ownership to mutual funds to alternative investments, such as hedge funds.

Investors looking for ways to diversify their portfolio outside of the more traditional asset classes associated with stocks and bonds will, at times, turn to commodities.

Historically, commodities have provided performance that often diverges from the stock and bond markets. “From a tactical perspective, commodities can offer opportunities from time-to-time,” says Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management. “This is best in circ*mstances where a broad commodity complex is in short supply, driving up prices.” The 2021-2022 surge in energy prices demonstrates the impact of an imbalance between supply and demand.

You can invest in commodities in more than one form and with more than one product. There are futures contracts, exchange-traded products and mutual funds. One of the appeals of commodities is the range of products available. For example, you can invest in agriculture, natural resources, precious metals and livestock. You may also simply buy physical raw commodities, such as gold or silver.

Why invest in commodities

  • Commodities may minimize portfolio volatility. Weather, politics or global production can affect commodities returns, so the historical correlation of commodities to traditional assets is low. As a result, the returns from commodities may help reduce volatility in a diversified portfolio.
  • Commodities can be a hedge against inflation. Commodity prices often follow inflation and may provide a defense against the impact of rising prices. Read more about the effect of inflation on investments.
  • Commodities can be physical assets. Hard commodities, such as gold, may be considered a store of value. This is especially the case when a base level of demand exists. As demand rises, there may be potential for price increases.

How to invest in commodities

As an investment, commodities come in many forms. Some can be as complex as direct ownership of physical commodities or as easy as purchasing a mutual fund that focuses on commodities.

  • Physical ownership. This is the most basic way to invest in commodities. But unless these are small, transportable assets like precious metals, it can be impractical. It’s not reasonable or desirable for individual investors to store bales of cotton or barrels of frozen orange juice concentrate. Owning these types of commodities is usually best left to those who will be turning that commodity into a finished product.
  • Futures contracts. Futures originated as a way for farmers to set a price for future delivery of goods. These contracts are perhaps the most well-known method for investing in commodities. Futures contracts have price-mechanism transparency, and you can access a commodity futures contract for a small fraction of its value, but there are risks involved. Buying and selling futures contracts requires skill and experience. If the forward price, or what you paid for the contract, is higher than the spot price when the contract comes due, you’ll lose money.
  • Individual securities. Shares of commodity-producing companies grant you indirect access to the commodity markets. If the commodity rises in price, the companies producing that commodity may experience increased revenues and profits. “If someone invests in stocks of oil companies, there tends to be a relationship to oil price trends over time, but sometimes there is a disconnect,” says Haworth. This is one limitation of relying on individual securities as a way to diversify into commodities.
  • Mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs). These securities can provide you wide exposure with relatively low investment minimums. Funds can be specific to a particular commodity, such as gold or precious metals, or cover a broader array of commodities. “Funds are invested in futures contracts and don’t own physical commodities,” notes Haworth.
  • Alternative investments. Hedge funds or private investments specializing in commodities are an option. These are highly speculative and leveraged investment strategies, carrying a high degree of risk and volatility. Enhanced returns are a possibility, but there is no guarantee of success. It’s a good idea to work with a financial professional before taking this approach. Read more about these two types of alternative investments.

Common commodities terminology

If you’re thinking about investing in commodities, it’s good to know the terms of the trade. Here are some key terms associated with trading commodities.

  • Commodity: Raw materials and unprocessed goods that are either consumed directly or are processed and resold, such as gold, oil, wheat, cattle and aluminum.
  • Forward price: The agreed-upon price of an asset in a forward contract where prices are set now but delivery and payment will occur at a future date.
  • Futures: An exchange-traded derivative. A future represents an obligation to buy or sell some underlying asset in the future for a specified price
  • Index performance: Most commodity ETFs/ ETNs and mutual funds track a commodity index like the S&P GSCI. Investors should be aware that indices don’t always track with spot prices of specific commodities.
  • Spot price: The price quoted for immediate payment and delivery of a specific commodity. This price applies only to delivery.

Setting proper expectations

Haworth cautions that commodities should only play a limited role in your portfolio, perhaps used more as a tactical strategy for certain economic or market environments. “Broad commodities probably shouldn’t be part of a long-term portfolio strategy,” says Haworth. “You’re not sufficiently compensated for the risk. They may generate equity-like returns, but typically with much more volatility and unpredictability.”

Be sure to consult with your financial professional to determine when and how an investment in commodities can be appropriate for your portfolio.

Learn how we approach your long-term investing success.

The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Indexes mentioned are unmanaged and are not available for direct investment. The S&P GSCI is a composite index of commodity sector returns, representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. Investing in futures contracts involves substantial risk and they are not suitable for all investors since the size of futures contracts can be very large and investors can gain or lose a substantial amount of money regardless of the direction in market movement.

Why and How to Invest in Commodities | U.S. Bank (2024)

FAQs

Why and How to Invest in Commodities | U.S. Bank? ›

You can invest in commodities in more than one form and with more than one product. There are futures contracts, exchange-traded products and mutual funds. One of the appeals of commodities is the range of products available. For example, you can invest in agriculture, natural resources, precious metals and livestock.

Why should you invest in commodities? ›

Investing in commodities can provide investors with diversification, a hedge against inflation, and excess positive returns. Investors may experience volatility when their investments track a single commodity or one sector of the economy. Supply, demand, and geopolitics all affect commodity prices.

What are the top 3 commodities to invest in? ›

You can invest in commodities in a range of ways. Today, the top three in the list of commodities are crude oil, gold and base metals. It is worth taking a look at all three and finding out how to invest. Crude Oil - After crude oil is produced, it is refined into several products.

Can banks invest in commodities? ›

Banks are not only a major source of credit and funding liquidity for commodities traders – as just discussed – but also provide funding for other commodities firms (e.g. commodities producers and consumers) as well as financial institutions (e.g. hedge funds) in the commodities ecosystem.

How to invest in commodities ETF everything you need to know? ›

A commodities investment is generally realised through an investment in forward or futures contracts. Commodity indices usually track a basket of commodities. There are several indices available to invest with ETFs in a broad basket of commodities.

How to invest directly in commodities? ›

How to invest in commodities
  1. Physical ownership. This is the most basic way to invest in commodities. ...
  2. Futures contracts. ...
  3. Individual securities. ...
  4. Mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs). ...
  5. Alternative investments.

What is the benefit of commodity? ›

*Diversification: *Commodities and commodity stocks usually provide returns that differ from other stocks and bonds during volatile markets. Hence, they can act as a good investment avenue. Investors having a portfolio of assets will manage such situations, but there is always no guarantee about the returns.

What is the number 1 commodity? ›

Crude oil is by far the biggest commodity market, and oil prices were the talk of the town for much of 2022. Following Russia's invasion of Ukraine, WTI crude oil prices rose to their highest level since 2013 by May 2022.

What is the number 1 traded commodity? ›

The most traded commodity is crude oil.

What commodity makes the most money? ›

1. Crude oil: Brent crude. Crude oil is one the world's most in-demand commodities as it can be refined into products including petrol, diesel and lubricants, along with many petrochemicals that are used to make plastics.

Which is the best bank for commodities? ›

Societe Generale was awarded "Best Commodity Trade Finance Bank" by Global Trade Review. Societe Generale has been named for the second time “Best Commodity Trade Finance Bank” in the GTR Leaders in TradeAwards 2023 which recognises the bank's expertise across commodities markets globally.

Which banks offer commodity trading? ›

Clearing Banks
Clearing BankAddress
The Hongkong & Shanghai Banking Corporation Ltd.52/60 M G Road Fort Mumbai - 400 001
ICICI Bank Ltd.Capital Market Division Raja Bahadur Mansion, 30, Mumbai Samachar Marg, Fort, Mumbai - 400001
HDFC Bank Ltd.2nd Floor, Trade World "A" Wing, Kamala Mills Lower Parel (W) Mumbai - 400013
11 more rows
Jan 4, 2023

How do investors make money from commodities? ›

You can also profit off commodities by using futures contracts, which is an agreement to buy or sell a commodity at a specific price and date. You can make a lot of money through futures contracts if you're right about the underlying commodity price, but you can lose a lot too.

What is the best commodity to invest in? ›

Fossil fuels lead the portfolio with commodity investments in oil and gasoline, but other materials, such as gold, copper, wheat and corn, are also key assets. And with a dividend yield of about 4.0%, you'll get roughly three times the income potential of the S&P 500 even as you get direct commodity exposure.

Does Vanguard have a commodities fund? ›

Overview. Objective: Vanguard Commodity Strategy Fund seeks to provide broad commodities exposure and capital appreciation.

What are the problems with commodity ETFs? ›

Commodity ETFs are notoriously volatile because of the supply-and-demand characteristics of their underlying holdings, which can be dramatically impacted by certain events.

What is the advantage of commodity money? ›

The primary advantage of commodity money is that commodities tend to have greater intrinsic value. Further, because of this intrinsic value, commodity money is not as susceptible to inflation as fiat money is. Finally, commodity money may be less susceptible to government regulation.

Why are commodities important to the economy? ›

Commodities are raw materials used to manufacture consumer products. They are inputs in the production of other goods and services, rather than finished goods sold to consumers. In commerce, commodities are basic resources that are interchangeable with other goods of the same type.

Is Investing in commodities profitable? ›

Apart from equities, investors can also trade commodities in the market. This way, investors can easily diversify their investment portfolio and increase their profits. Moreover, commodities can generate great returns in the long term when people invest with prudence.

Is now a good time to invest in commodities? ›

Commodities stand to benefit from underinvestment and the clean energy transition. PIMCO has a positive outlook for commodities based on supply constraints, the transition to a net-zero economy, and their historical correlation with inflation.

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