Commodities cover a wide range of opportunities: precious metals (gold, silver, copper), oil and gas, corn, sugar, cocoa, soy, even hogs. Basically, a commodity is any product that can be marketed for people to use, collect or trade. Values are highly correlated to the law of supply and demand.
For example, if a drought strikes an area that grows an abundance of corn and the same amount of people want to buy corn, the price will rise because demand exceeds supply. On the contrary, if the world starts driving electric cars and stops buying gas, prices at the pump would fall.
It seems like a simple enough equation, but investing in commodities can be tricky and risky for individual investors. That’s because much of the commodities market is based on futures contracts.
Commodities: Risks and Warnings
- Very risky and volatile.
- Future bets determine prices.
- Vulnerable to geopolitical events.
For example, a farmer can sell a crop before it’s planted even though he might get a better price in the future. If demand grows unexpectedly, it will drive up prices by harvest time. But if a highly productive crop floods the market and prices drop, someone betting on higher prices could lose everything. No matter what happens, the farmer has enough money in the bank to buy the seed for next year’s crop.
Because of all of these bets on short-term movements, and that’s what they really are, prices can move often and be unpredictable. Unless you really know what you’re doing with respect to futures contracts or options, you will be better off investing in commodities funds.
Both mutual funds and ETFs have commodities-based options. They generally track an index based on a commodity or hold a mix of related commodities like some ETFs do.
For example, Fidelity Select Gold (FSASX) invests mainly in companies involved in the exploration, mining, processing, or dealing in gold, or to a lesser degree, in silver, platinum, diamonds, or other precious metals and minerals. The United States Oil Fund (USO) is an ETF that reflects the performance of the spot price of West Texas Intermediate (WTI) light, sweet crude oil.
Another inherent risk to investing in the commodities market is geopolitical. For example, the Middle East produces a large amount of crude oil. If a war erupts or sanctions are placed on a country by the United Nations it could affect the price. Those types of events are out of our control and add to risk.
Commodities can be a good investment for times of high inflation. Never commit 100% to this sector but it’s OK to devote a small percentage as a hedge against stock volatility.
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