Commodities, whether they are related to the food sector, energy or metals, are a fundamental part of people's lives. Similarly, commodities can be an option for investors seeking to diversify their portfolio beyond traditional bonds and equities, or to profit from the price movements of these assets.
Previously most people preferred not to invest in commodities because this required a lot of money, knowledge and time. Today there are several routes to invest in commodity markets, and some of these routes allow it to be easier to participate in these markets, even for the average investor. In this article we will describe the main options for investing in commodities.
Futures market
A rather popular option to invest in commodities is through futures contracts, which are basically agreements to buy or sell, in the future, a specific amount of a commodity (or other asset) at a specific price. Traders can now operate with commodity-based futures such as crude oil, gold and natural gas as well as agricultural products such as maize, soybeans and livestock.
Most of the participants in the futures markets are commercial or institutional users of the commodities they negotiate in these markets. These actors can use commodity markets to take a position that allows them to reduce the risk of financial loss due to price changes. Other participants, mainly individuals, are speculators who expect to profit from changes in the price of futures contracts. Speculators usually close their positions before the contract expires and they never receive the delivery of the commodity itself.
Investment in futures contracts requires the opening of a brokerage account with a broker operating with futures. In most cases, these companies require the trader to complete a form where he recognizes that he understands the risks associated with trading with futures.
Each commodity contract requires a separate minimum deposit, depending on the broker, and the value of the trader's account is increased or decreased with the value of the contract. If the value of the contract falls too far with respect to the account capital, the trader may be subject to a Margin Call, and will therefore be asked to deposit more money into your account if you want to keep the position open. Due to the high leverage amounts, small variations in prices can produce high returns or losses, so that an account to operate with futures can lose its capital or double its value in a matter of minutes.
Many futures contracts also have associated option contracts. Options on futures contracts also allow investing in futures, but limit trader losses at the cost of the option. The options are derivatives and usually do not move point by point with futures contracts.
Advantages of Futures
They allow transactions based on a commodity that acts as an underlying asset.
Leverage allows for great benefits if the trader manages to correctly predict the direction of the market.
By means of relatively low minimum deposits in trading accounts, the investor or trader can control standard-size contracts that would normally not be able to pay for lack of resources.
They offer the possibility to carry out buying or selling operations (long or short) with ease.
Disadvantages of futures contracts
Futures markets can be highly volatile and transactions with futures in these markets can be highly risky, especially for non-experienced traders.
Leverage can also magnify losses.
An operation can quickly turn against the trader, which may lose its initial (and even more) deposit before being able to close the position.
Actions
Many investors interested in investing in commodities employ shares of companies related to these assets, which are less likely to experience significant price fluctuations compared to commodity futures markets. Investors in action need to conduct research and analysis to help ensure that a particular company is a good investment and a good way to make money
with commodities, albeit indirectly.
with commodities, albeit indirectly.
Oil companies allow investors to choose between drilling rigs, refineries, oil tanker companies or diversified oil companies. Actions are easy to buy, keep, negotiate and follow, and it is possible to negotiate and speculate with a particular sector.
Stock options, which require lower investment compared to direct stock purchases, are another way to invest in commodities. While the risk is limited to the cost of the option, the price movement usually does not directly reflect the price of the underlying action.
Advantages
Negotiating with stocks or stock options can easily be done through a trading account with one of the many broker-dealers who offer this service today.
Public information about a company's financial situation is available to any investor.
Usually stocks have a highly liquid market.
Disadvantages
An action is not a way to invest directly in commodities or to speculate directly with the price of these.
The price of the shares can be influenced by specific factors of the companies as well as by conditions of the market.
Exchange traded funds (ETF) and exchange traded Notes (TNC)
Publicly traded funds (ETF) and exchange traded Notes (TNCs), which are negotiated as shares, allow investors to profit from commodity price variations without having to invest directly in futures contracts.
Commodities ETF usually follow the price of a specific commodity or a group of commodities that make up an index by using futures contracts, although some of these ETF are backed by real stocks of the same asset that they are in storage.
For its part, the TNCs are uninsured debts designed to mimic the fluctuation of the price of a particular commodity or an index of commodities, and are supported by the issuer. A special brokerage account is not required to invest in ETF or TNCs.
Advantages
Because ETF and TNCs are negotiated as shares, the investor must not worry about the payment of any management-related expenses or the like.
They provide a simple and accessible way to profit from the fluctuation of the price of a commodity or set of commodities.
Disadvantages
It may occur that a strong movement in the price of the commodity is not reflected point by point by the ETF or TNC that follows it.
Not all commodities have an ETF or an associated TNC.
TNCs have a credit risk associated with the issuer.
Mutual funds and index funds
Although mutual funds cannot invest directly in commodities, they can invest in stocks of companies involved in industries related to these products, such as energy, mining or agriculture companies. Like the shares in which they invest, the shares or share of these funds may be affected by various factors other than commodity prices, including market fluctuations in securities and risks related to companies.
A small number of commodity-based index mutual funds invest in commodity-related futures and investment contracts, which provides more direct exposure to commodity prices. An index fund is a mutual fund with a portfolio built to match or follow the components of a market index. Among its greatest advantages we can emphasize that they offer a greater exposure to the market, they have less operating costs and a low turnover of the portfolio.
Advantages
They have professional capital management.
They provide investment diversification.
A high level of liquidity
Disadvantages
Because commodity mutual funds invest in stocks, they are not a direct way to invest in commodity markets.
Management fees may be high, and some of the funds can also charge sales charges.
Managed Futures
An operator of the Tangible Goods Consortium (CPO) is a person or limited liability company that collects money from investors, combines it into a single consortium and invests it in futures and options contracts. The CPO must present a risk-disclosure document to investors and must also distribute periodic statements as well as annual financial reports. It is also required to keep a strict record of all the investors, transactions and consortia that are operating.
The CPO employs a tangible property negotiation Counselor (CTA) to advise them regarding their investment decisions for the consortium. In the United States, CTA must be registered with the CFTC (Commodity Futures Trading Commission) and are required to go through an FBI background check before they can provide investment advice. They usually have a system to operate with futures and employ them to recommend transactions to the CPO.
Advantages
They offer professional advice.
A combined structure that allows the manager to have more money to invest.
Are closed funds that require all investors to put in the same amount of money
Disadvantages
It is difficult to assess past performance, and an investor may be interested in seeing the CTA's risk-adjusted return on previous investments.
Investors must read the CTA disclosure documents and understand the trading program, which may be susceptible to periods of drawdowns or loss.
Conclusions
There are a variety of commodity-based investment options that are accessible to both experienced and novice investors. Although futures contracts provide the most direct way to profit from the price movements of these assets (with the exception of some commodities that can be negotiated directly in spot markets such as gold and silver), other forms of investment with variable risks and different investment profiles also provide exposure to commodity markets. The key is to invest with the tool that works best for the investor.
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