Commodities are raw materials used to make other products. These range from agricultural (wheat, corn, soy) and metals (gold, silver, copper) to energy (crude, natural gas, heating oil) and more. Anyone who drives a car can become significantly impacted by high crude oil prices. Anyone who eats might feel the impact of a drought on the soybean supply. A failed coffee harvest, rice harvest or an increasing demand for pork from China have an influence on commodity prices.
Commodities investing is the way in which investors, from individuals to large banks, can make money trading commodities and commodity securities by taking advantage of these movements. Commodities can also be an important way to diversify a portfolio beyond traditional securities – either for the long term or as a place to park cash during unusually volatile or bearish stock markets, as commodities traditionally move in opposition to stocks (but this is not a guarantee).
Commodities dealing is a very old profession, far older than dealing in stocks and bonds. Ancient civilizations traded a wide array of commodities, from seashells to spices. There are some mentions in the Bible.
In the more recent past, commodity trading was primarily done by farmers who wanted to make sure that their crops would get a guaranteed price.
Basic economic principles of supply and demand typically drive the commodities markets: lower supply drives up demand, which equals higher prices, and vice versa. Major disruptions in supply, such as a widespread health scare among cattle, might lead to a spike in the generally stable and predictable demand for livestock. On the demand side, global economic development and technological advances often have a less dramatic, but important effect on prices, too.
There are several ways in which you can invest in commodities. One is to actually purchase the physical raw commodities, such as gold. Investors can also invest through the use of futures contracts or exchange-traded products (ETPs) that directly track a specific commodity index. These can be highly volatile and complex investments that are generally recommended for sophisticated investors only.
Another way to gain exposure to commodities is through mutual funds that invest in commodity-related businesses. For instance, an oil and gas fund would own stocks issued by companies involved in energy exploration, refining, storage, and distribution.
There are a variety of commodity investments for novice and experienced traders to consider. Although commodity futures contracts provide the most direct way to participate in price movements, other types of investments with varying risk and investment profiles also provide opportunities. Therefore, most stock investors feel more comfortable tying their prospects to those of companies in the business. Commodities can quickly become risky investment propositions because they can be affected by eventualities that are difficult, if not impossible, to predict: unusual weather patterns, epidemics, and disasters both natural and man-made. Therefore, it may be a good idea to allocate only a small part of a portfolio to commodities.