Posted on 27 August 2011.
Commodity investment is different than commodity trading because an investment is a long term commitment of money to a commodity investment vehicle that an investor assumes will increase in value over a long period of time. Whereas, commodity trading involves implementing any number of short term commodity trading strategies to profit from commodity price fluctuations.
While many investors are weary of investing in commodities since they do not understand how the commodity markets and commodity investing works, commodity investment is pretty straight forward and is very similar to buying and holding stocks. It is important to understand the basics of commodity markets and commodity investment prior to considering investing in commodities. For more information about what a commodity is how commodities trade, see Commodity Trading.
Commodities trade via contracts between buyers and sellers, which can consist of: spot commodity prices, commodity forwards, commodity futures, and options on commodity futures. Commodity investors do not use these commodity contracts and options directly to invest in commodities since they expire and are more suitable for trading. Commodities investors can invest in a wide variety of commodities via Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) that buy commodity contracts and options. When the commodity contracts and options expire, the commodity based ETFs and ETNs buy more of the same commodity contracts and options for future months, in accordance with their bylaws. The performance of the ETFs and ETNs is correlated to the performance of the underlying commodity contracts and options.
The investment strategy employed when investing in commodities is pretty much the same as going long or short stocks or stock investment vehicles like ETFs or mutual funds. The primary difference is that a commodity investor must take the time to fully understand the market forces that affect the commodity investment that they are considering. Unlike stocks, which are primary driven by earnings and growth outlooks, commodity prices are affected by a wide variety of factors, including but not limited to: supply and demand, inventories, weather, political instability, currency prices, currency devaluation, inflation rates, and market sentiment.
Many financial advisors advise clients to diversify their investment portfolio into a number of various asset classes, including commodities. Investing in commodities is considered an essential part of an investment diversification strategy because commodities are affected by different factors than stocks and other asset classes such as real estate and bonds, and can serve as a hedge against declines in stocks and other assets classes. While there no longer appears to be a strong inverse relationship between stock prices and commodity prices, diversifying an investment portfolio with commodity investments is a good way to ensure investment dollars are protected from stock market declines.
Those who wish to make commodity investment part of their investment strategy are encouraged to learn as much as possible about commodity investment, which can be a very useful investment tool to make money on commodity price changes and can serve as a hedge against price declines in other investments.
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