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Discover what commodity investing is and how to get started in this dynamic market.

Commodity Investing: Definition & How to Start

Disclaimer: This website and its content are for informational purposes only and is not financial advice.

What Exactly is Commodity Investing?

Commodity investing refers to the act of putting capital into raw materials or primary agricultural products. These are tangible goods that are often interchangeable with other goods of the same type, meaning one bushel of wheat is essentially the same as another, regardless of where it was grown, provided it meets a standardized quality.

This fungibility is a key characteristic of a commodity. Unlike stocks, which represent ownership in a company, or bonds, which represent a loan to an entity, commodity investing is about gaining exposure to the price movements of these foundational resources.

The value of a commodity is primarily driven by the forces of supply and demand. Factors such as weather events, geopolitical tensions, technological advancements, and economic growth can significantly influence these dynamics, leading to price fluctuations.

A World of Commodities: Hard and Soft

The universe of commodities is vast and can generally be categorized into two main groups: hard commodities and soft commodities.

Hard commodities are typically natural resources that are extracted or mined from the earth. This category encompasses a wide range of essential materials. Precious metals like gold, silver, platinum, and palladium are often sought after for their store of value, and as an inflation hedge.

Stocks like the Americas Gold and Silver Stock, or the Wheaton Precious Metals Stock can be a great way to gain exposure to these commodities.

Industrial metals such as copper, aluminum, zinc, and nickel are crucial for manufacturing, construction, and infrastructure development. Energy commodities, including crude oil, natural gas, gasoline, and heating oil, are vital for powering industries, vehicles, and homes.

This makes them some of the most heavily traded commodities globally. Commodity investing in these areas often involves considering global economic health and industrial output.

Soft commodities, on the other hand, are agricultural products and livestock, often cultivated or raised. Grains like corn, wheat, and soybeans are fundamental to the global food supply. Other agricultural products such as coffee, cocoa, sugar, and cotton also fall into this category.

Livestock commodities include cattle and hogs. The prices of soft commodities can be particularly susceptible to weather patterns, disease outbreaks, and shifts in consumer preferences. When engaging in commodity investing with soft commodities, it is important to consider these unique supply-side factors.

Why Consider Commodity Investing?

There are several compelling reasons why investors might consider adding commodity investing to their portfolios. One of the most frequently cited benefits is diversification. Commodity prices often do not move in lockstep with traditional asset classes like stocks and bonds.

In fact, they can sometimes move inversely, meaning when equities or fixed-income markets face headwinds, commodities might offer a protective buffer. This low correlation can help reduce overall portfolio volatility and enhance risk-adjusted returns over the long term.

Another significant advantage of commodity investing is its potential as a hedge against inflation. When inflation rises, the cost of raw materials typically increases, which in turn can drive up commodity prices.

This can help preserve purchasing power, as the value of commodity investments may appreciate during inflationary periods, offsetting the erosion of value in other assets. For those concerned about rising living costs, commodity investing can serve as a strategic tool.

Furthermore, commodity markets can offer potential for capital appreciation. Supply and demand imbalances, often influenced by global economic cycles and unforeseen events, can lead to substantial price swings.

Savvy investors engaged in commodity investing may seek to profit from these price movements, aiming to buy low and sell high.

Updated May 24th, 2025

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How to Begin Commodity Investing

For most individual investors, direct physical ownership of commodities is impractical due to storage, transportation, and quality control issues. Fortunately, there are several more accessible and liquid ways to gain exposure to commodity markets.

Direct Exposure through Futures Contracts:

• Mechanism: A futures contract is a standardized legal agreement to buy or sell a particular commodity at a predetermined price on a specified future date.

• Trading: These contracts are traded on exchanges, allowing investors to speculate on future price direction without taking physical delivery of the commodity.

• Suitability: While offering significant leverage and profit potential, futures contracts carry substantial risk and are generally more suitable for experienced investors due to their complexity and volatility.

Indirect Exposure through Funds:

• Commodity Exchange-Traded Funds (ETFs) and Mutual Funds:

  • Structure: These funds pool money from many investors to invest in a basket of commodities or commodity-related assets.

  • Investment Focus: Some funds directly hold physical commodities (though less common for most), while others invest in commodity futures contracts or in the stocks of companies involved in commodity production, extraction, or processing.

  • Benefits: They provide a convenient way to gain broad exposure to the commodity market, offering diversification within the commodity space and typically lower entry barriers than direct futures trading. These funds are often structured to track a specific commodity index.

Indirect Exposure through Equity Investments:

• Company Stocks:

  • Method: Invest in the stocks of companies whose businesses are directly tied to commodities.

  • Examples: This includes buying shares in oil and gas exploration companies, major agricultural firms, or gold mining companies.

  • Correlation: While this method does not directly involve commodity ownership, the profitability and share price of these companies are often closely correlated with the underlying commodity prices, offering an indirect way to participate in commodity investing.

Important Considerations Before Investing:

• Volatility: Commodity markets can be highly volatile, with prices influenced by a multitude of unpredictable factors such as geopolitical events, natural disasters, economic downturns, and changes in regulatory policies.

• No Income Generation: Unlike stocks that might pay dividends or bonds that pay interest, commodities generally do not generate income; returns primarily come from price appreciation.

• Due Diligence: Careful research, a clear understanding of your risk tolerance, and a well-defined investment strategy are paramount when engaging in commodity investing.

In conclusion, commodity investing offers a compelling avenue for portfolio diversification and potential inflation hedging, providing exposure to the foundational elements of the global economy. Whether through futures contracts, commodity-focused ETFs and mutual funds, or by investing in commodity-related companies, there are various ways to participate.

With a thorough understanding of the markets and a disciplined approach, commodity investing can be a valuable component of a well-rounded investment portfolio.

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