Commodities are considered alternative investments because they don’t fall into the main categories of stocks, bonds or cash.
These internationally traded raw materials often form relatively small portions of retail investor portfolios. But they can serve important roles, such as hedging against inflation or being a safe haven amid market worries.
While commodities can exhibit strong short-term gains, their short-term losses can also be sharp. Speculators often try to time these fluctuations, but long-term holders understand that the primary allure of these raw materials is their ability to provide diversification.
“Commodity investments have a place in any diversified portfolio, often providing very different risk profiles to traditional equities or fixed income,” said Lucas Kiely, chief investment officer with digital wealth management platform Yield App. “As such, they will always be with us, but unlikely to shoot the lights out.”
Understanding commodity investing
While each commodity has its particular price drivers, one commonality is volatility.
That’s because commodities are tied to economic cycles. When economies are doing well, or when they are expected to improve shortly in the future, industrial commodities like copper and crude oil can outperform because of increases in demand or speculative trading.
Agricultural commodities, such as soybeans, wheat or livestock, are also subject to supply and demand.
Supply can be even more fickle for agricultural commodities than for metals, as planting cycles are much shorter than mine development and life cycles. And unlike metals, agricultural products are always subject to the whims of nature, whether it be drought or floods.
Popular commodities for investment
According to Bob Minter, director of ETF investment strategy at abrdn, a global asset management company, the top-five most popular commodities are oil, natural gas, gold, silver and copper.
Of these, oil has the biggest market, but gold is the most popular commodity for holding long term because of its role as a risk hedge, according to Minter.
A portfolio of these commodities would span the energy market, with its dynamics including transportation and home heating; industrial metals with their dependence on manufacturing cycles; and precious metals with their reliance on financial market dynamics.
What factors influence commodity prices?
Economic cyclicality
The reason commodities are particularly volatile investments is because most of them are highly correlated to economic cycles.
Copper is a prime example of dependence on economic cyclicality. The red metal is sometimes referred to as “Dr. Copper,” as if it has an advanced degree in economics, because it is used in so many industrial applications.
Global politics
“Risk profiles vary depending on what you’re investing in,” Kiely said. “Oil, for example, is heavily influenced by global politics, and prices can spike pretty wildly depending on tensions in oil-producing areas, of which there are often many.”
Supply & demand
“The price of oil, gold, silver, copper and others are only based upon supply versus demand,” said Steven Conners, president of Conners Wealth Management. “This can make them riskier, especially if supply exceeds demand. If there is a shortage of a commodity, the price can appreciate notably.”
However, gold is influenced by supply and demand in a much different way than industrial metals or energy commodities are. Supply is heavily influenced by mine output. But demand is often driven by financial interests of central banks and investors rather than raw industrial demand.
Industrial applications
Other metals, including silver, platinum and palladium, can also function as precious metals for investors. But they also have much wider industrial uses than gold does, giving the yellow metal a unique role in the global financial system and investor portfolios.
One of the biggest factors affecting commodities investing is economic activity in China. That’s because the Asian nation’s huge population and role as a key global manufacturing center mean it is a huge source of demand for industrial metals, coal, soybeans and many other commodities. It is also a large center for gold demand.
“Over 50% of global commodity demand is generated inside China, making the outlook there critical to commodity direction,” Minter said. “Current consensus is for 4.6% economic growth in China, hardly a recession.”
Different methods to invest in commodities
One of the main methods for investing in precious metals is through physical ownership of bars and coins. But those have to be stored and insured, which cuts down…