Commodity prices tend to move higher during periods of inflation. Sometimes the economy exhibits high levels of inflation, as the late 1970s and 1980s is a prime example. Interest rates reached 19% to combat the high levels of inflation, and commodity prices reached record highs during this period. Not all periods of inflation are this extreme, but commodities can perform well during periods of mild inflation.
Trading or Investing in Commodities
Buying commodities for a long term investment have become much more popular in recent years. The advent of commodity ETFs has made this process much easier. There are also other investments like managed futures that can make money regardless of which direction the price of commodities move. If you are investing in commodities using a percentage of your investment portfolio, timing isn’t necessarily as important as it is for trading commodities.
The two most common times when investors flock to commodities is during times when commodities become very cheap, and commodities are considered a value play. The other time is when commodities are hitting multi-year highs and investors want to catch the trend. In reality, most asset classes attract the most investment dollars after they experience a period of high returns. Sometimes this is a good philosophy, but often investors buy at the top of the market.
Commodities, in essence, are a hedge against inflation. Over a period of decades, commodities typically keep pace or exceed the rate of inflation. Therefore, a buy and hold strategy makes sense, regardless of when an investor buys commodities.
When trading commodities, many strategies can be utilized to take advantage of price trends. One of the more common strategies is scale trading when the price of a commodity reaches multi-year lows. Once a commodity falls below the cost of production, the theory is that the price probably won’t fall much lower and a major bottom is near.
Commodity traders don’t necessarily need commodity prices to move higher to make money. Trading with futures contracts allows commodity traders to get in and out of the markets easily, as well as making money from commodities moving lower. Commodity traders typically use a particular trading strategy and take advantage of short-term movements in commodity prices.
Best Time to Buy Commodities
There is no set formula for the best time to buy commodities, just like stocks. It really depends on an investor’s time horizon and investment goals. Buying cheap is often the better route in my opinion if you have a long-term investment horizon.
The gold market is a good example. The price of gold reached $850 an ounce in 1980, which was an extraordinary price for the time. Many investors were buying gold during the frenzy and found themselves buying at a high price the would not be achieved for another 28 years. On the other end of the spectrum, gold prices reached multi-years lows in 1999 near $250 an ounce. This price was near or below the cost of production and likely close to a floor in price. Gold prices subsequently mounted a decade-long rally dwarfing the previous record high in 1980.
Not all markets play out like the previous example, but it is a good representation of the commodity markets. Sometimes it takes much longer for prices to turn around, but they often do. When investing in a commodity index, it makes things more difficult as some commodities might be near 10-year highs and others might be near 10-year lows. If you can do a little market analysis, there are plenty of vehicles that allow you to invest in individual commodities.
Commodities as an Investment
Just as an investor would buy stocks in an investment portfolio for long-term returns, the same can and should be done for commodities. Regardless of whether commodities are at multi-year highs or lows, an investor can enter at any time. The returns should do well over a holding period of a couple of decades if you buy a broad index of commodities. Remember that commodities are often considered a hedge in an investment portfolio. If commodities are underperforming for a period, it is likely that other investments in a diversified portfolio are doing well.