Commodities are items that are consumed by businesses, governments, and people. Generally, commodities are naturally grown or naturally occurring resources that are collected and sold. Examples of commodified items we use every day are precious metals, corn, wheat, and oil.
Most people are consistent consumers of commodities, which means we have a wealth of knowledge about many of these things. If you're interested in investing, consider using the everyday expertise you gain as a commodity consumer to hone your investment skills and grow your nest egg.
- Some investors trade commodities futures directly, though commodities ETFs and exchange-traded notes allow indirect exposure to commodities as well.
- Everyday commodities include energy and fuels, precious metals, other metals, grains, soft commodities like coffee, and animal proteins or products.
- You can select commodities to invest in by considering what products you and those around you use the most.
Investing in Commodities
Commodities trade on the commodities exchange, which is regulated by the Commodity Futures Trading Commission (CFTC) rather than the Securities Exchange Commission (SEC). Most commodity investors trade on the exchanges using instruments based on commodity exchange prices.
These securities are called "commodity futures," and commodity exchange-traded funds (ETFs) or exchange-traded notes (ETNs) allow investors indirect access to commodities trading.
Commodity suppliers and purchasers create contracts that specify an amount, price, and delivery date. Both parties can gain or lose value, depending upon the commodity price at the time of sale.
Suppliers, purchasers, and investors can all lose or gain significant amounts of money in commodity futures.
For example, a purchaser signs a contract for 30 bushels of corn for $100 in May to be delivered in August. In August, if 30 bushels of corn sell for $75, the purchaser still will have to pay $100. The supplier will have gained $25, while the buyer will have lost it unless they can sell it somewhere else and gain it back. The securities created based on bushels of corn also gain or lose value from the price difference, affecting the returns of commodities investors.
Commodities We Consume Every Day
Six main segments in the commodity markets trade on U.S. futures exchanges. These commodities offer a high degree of liquidity, and most have ETF and ETN products that attempt to replicate price action in the futures contracts.
Here are some of the most typical commodities that have securities traded by investors:
- Precious metals
- Other metals
- Soft commodities
- Animal proteins and products
We put gasoline in our cars, heat and cool our homes, and use electricity to power many things daily. Crude oil, petroleum products like gasoline and heating oil, and natural gas are some of the main ingredients in fueling our lives.
Energy commodities generally trade on a highly liquid basis (they are easily bought and sold) on futures exchanges and have ETF and ETN products that replicate price movements (price fluctuations) in the futures and physical markets.
Gold, silver, platinum, and palladium each play a part in our daily lives. If we wear or buy jewelry, we are consumers of precious metals. When we drive a car, our automobile likely has a catalytic converter containing precious metals with high melting points.
When we turn on the water faucet, the water flows through pipes that likely contain copper. The homes we live in and the cars we drive contain steel, zinc, nickel, and tin. We wrap our leftovers in aluminum foil or have aluminum siding on our homes. We use batteries that contain lead or other metals that store power.
Investing directly in commodities means that you need to be able to take possession of them upon the expiration of the contract. ETFs and commodity derivatives allow you to invest without physical responsibility for the items.
The main ingredient in most bread is wheat. Corn is an important food source for humans and the animal proteins we eat, but it is also a critical biofuel in the U.S. Each time we fill our car with gas, a percentage of the fuel is corn-based ethanol. We consume mayonnaise, salad dressings, and cooking oils that are products of soybeans.
Many of us start the day with a cup of coffee, possibly stirring in some sugar—both are soft products. We drink orange juice, eat chocolate, and wear clothes made of cotton.
Whether we eat a steak, burger, or hot dog for dinner, they all start as cattle that trade on the futures markets. Pork chops, bacon, or ribs are commodities traded on the hog market.
Using Your Commodities Experience
You know the commodities you consume every day. If you have staple items that are always on your grocery list, there is an excellent chance that someone else does, too. Some commodities are available seasonally, and some are available year-round.
Prices for commodities that everyone uses will continue to rise as demand increases, creating opportunities for higher returns over the long run.
Invest in commodities that you know through experience are available or in demand. Once you choose your commodities investments, be sure to monitor the industries they belong to, and learn some commodities-investing strategies to help you maximize your returns.
The population of our planet continues to expand. Commodities are finite goods; there is only so much available. As global demand for raw materials increases, it will likely lead to increased demand and higher production costs, which increases commodity prices.
Commodity prices tend to respond more to shifts in both micro- and macroeconomic cycles than other assets do. Commodities are volatile assets, and many external factors impact their prices. Weather, political factors, civil unrest, and pandemics are all examples of circumstances that can cause prices to rise and fall within hours.
Choosing staple commodities that historically have created positive returns can help your portfolio grow, as long as you diversify your investments to reduce your risk exposure.