How to Invest in Commodities

Here's what to consider before investing in this asset class.

How to Invest in Commodities

Cattle, wheat and coffee are examples of soft commodities, which are grown. (Getty Images)

With stocks off to a slow start in 2022, inflation at 40-year highs, bond yields still on the low side historically and cryptocurrencies moving sideways, many investors will turn their eyes to real assets such as commodities to bolster their portfolios.

For those interested, there are a variety of ways to invest in commodities, such as in the futures market, through exchange-traded funds or by purchasing individual commodity-linked stocks.

But commodities are known for being volatile. "Commodity prices are highly cyclical, rising and falling with demand expectations," says Michelle Cluver, portfolio strategist at Global X.

And, as Cluver says, there are still global headwinds facing the commodity markets. "Commodity markets are currently balancing between the war in Ukraine creating uncertainty about supply and Chinese lockdowns raising concerns about lower global economic growth," she says.

So is it ideal to have exposure to commodities right now? This is what you need to know if you are interested in diversifying your portfolio with commodities:

  • Types of commodities.
  • 3 ways to invest in commodities.
  • Commodities as an inflation hedge.
  • Commodities as a hedge against stocks and bonds.

Types of Commodities

Commodities are raw materials that are used in the production of other goods and can be bought and sold. Commodities come in two types: soft and hard commodities. Soft commodities are grown, such as coffee, wheat or cattle, while hard commodities are natural resources that are mined such as gold, oil or natural gas.

In the world of investing, commodities are another asset class like stocks or bonds that can be traded in the markets.

Commodities play an important role in the economy, affecting the prices of food, gas, clothing and all manner of manufactured goods. In other words, just about everything you can buy. Rising prices of commodities such as oil, gas and wheat are among the drivers of the current wave of inflation.

Typically, when there is a rise in commodity prices, consumers will have to pay more for goods and services. This correlation can bode well for commodity investments.

3 Ways to Invest in Commodities

Commodity investing comes in several forms. Theoretically, you can directly invest in commodities like physical gold, corn or wheat, but the storage, transportation and maintenance of these goods are impractical for most individual investors. But there are other investment vehicles that offer a much easier way to access the commodity market:

Futures contracts. Commodities can be traded in the futures market. Commodities futures contracts are agreements to buy and sell commodities at a predetermined price at some time in the future. Futures trading involves speculation and requires knowledge of the particular commodity, so it may not be a suitable strategy for a beginner investor. Most participants in the futures markets are institutional producers and consumers.

Commodity exchange-traded funds.Commodity ETFs are a great way for individual investors to approach commodity investing. Commodity funds invest in raw materials, precious metals, energy resources and many others, depending on the fund's focus. Some also invest in a mix of companies that are involved in the production of commodities. Commodity ETFs are bought and sold on stock exchanges alongside individual stocks.

Commodity ETFs help investors gain exposure to the asset class while managing risk, since you can buy and sell them as your please. Some well-known commodity ETFs include Aberdeen Standard Bloomberg All Commodity Strategy K-1 Free ETF (ticker: BCI) for exposure to a wide array of commodities, SPDR Gold Shares (GLD) for precious-metal commodity investments, and United States 12 Month Oil Fund (USL) for energy investments.

Commodity stocks. Another way to gain exposure to commodities is by purchasing shares of commodity-related companies like oil stocks, gold mining stocks or agriculture stocks. This is an easy and indirect way to get involved in commodity investing. However, the risk is that stock prices are influenced by how the companies are performing operationally, rather than simply by changes in commodity prices themselves.

So investors must do their due diligence on investing in the commodity-linked companies that have strong business models and generate consistent profits. Some popular commodity stocks include the global mining company Rio Tinto Group (RIO), natural resource company BHP Group Ltd. (BHP) and gold mining company Barrick Gold Corp. (GOLD).

Commodities as an Inflation Hedge

The not-so-transitory inflation in the U.S. has been building for months, hitting an annual rate of 8.5% in March, according to the Labor Department's consumer price index. Commodities are one of the few asset classes that can serve your investments well in a rising inflationary economy.

"The U.S. remains in a mid-cycle expansion, with strong jobs numbers and growth prospects, leading to concerns that further demand will continue to drive commodity prices upwards," says Lindsey Repp, manager of Investment Strategy & Advice at Stash, an investing, banking, and education platform.

Commodities have been historically viewed as assets that protect against inflation since an increase in commodity prices is linked to higher consumer prices. If inflation persists, having exposure to commodities may be a good strategy for the time being.

Commodities as a Hedge Against Stocks and Bonds

Another attractive feature of commodities is that they tend to have a low correlation to stocks and bonds. This means they can outperform when stocks and bonds underperform.

Repp says that investors who have traditional stock and bond portfolios are concerned that their performance is not going to be as strong as it was over the past few decades as high inflation and rising interest rates define the economic climate.

"High-growth tech stocks, which the market has become highly concentrated in over the last decade, and bonds are two groups of securities that tend to struggle during periods of rising interest rates. Reducing some bond exposure and adding some commodity exposure can help make up for some lost ground," Repp says.

In both an inflation-intensive environment and a rising-interest-rate environment, investors may feel that they have nowhere to turn, says Joy Yang, global head of index product management at MV Index Solutions.

"Rising interest rates make bonds and many corners of the equity markets a poor choice, inflation makes cash a poor choice, and uncertainty over future economic growth also makes equities a risky choice," she says.

So where should investors go in this current economic environment? Yang says commodities serve the portfolio in managing both volatility and potential upside.

"Technically speaking, commodities, in general, should have a low correlation against traditional asset classes, which is why they are a good diversifier in any economic environment," she explains.

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