There are several ways you can participate in commodity investing. You can enter commodity positions through Direct Purchases, Equities, Funds, and Futures. Each way has its own benefits and its own downsides. Look at your entire portfolio and ensure that you are not magnifying losses that would occur from a singular adverse incident. The sources of both profits and risks should be diversified.
You can purchase commodities outright. This is a difficult commodity investing strategy which is fairly hard to control unless you have an existing arrangement for handling commodities professionally. It’s extremely difficult for private investors to handle 50 bars of gold and 30 barrels of petroleum being delivered to their doorstep. It is much easier for them to handle futures representing that many commodities.
Many Corporations handle commodities directly. These corporations are readily accessible via the equity markets. You can easily participate in commodity investing by purchasing shares of companies whom mainly produce, drill, refine, or transport commodities.
The primary benefit of commodity investing via equities of producers is being able to invest in specific production stages. Simply invest in a firm in the specific production stage desired: Refining, Transportation, Drilling, Mining, Retail sale, etc. This allows you to custom tailor risk exposure. The downside: If you choose a firm which specializes in one stage of production, you won’t benefit from other stages of production. When firms outside your selected specialization increase productivity, you won’t be able to capitalize.
Another potential drawback is any business specific problem affecting the firm. Firms do not perfectly track commodity performance. They are reduced by all typical risks to companies, including mismanagement and fraud. You must carefully analyze and research the firm’s issues. Pay even closer attention to political and social issues affecting the firm. Many commodity dealing firms operate internationally. Major firms often have holdings in regions that are not politically stable. This can manifest disaster in unexpected ways. Governments may seize businesses or nationalize industries. They can also suffer from licensing disagreements, property rights issues, tax issues, and other regulatory issues. At the end of the nightmare spectrum are strikes, rebellion, civil unrest, terrorism, vandalism, and war. If you desire maximum correlation with commodity markets, you should probably pass on firms specializing in commodities.
If you’re investing in commodities via firms, pay careful attention to their asset and property holdings. Read financial footnotes and listen to conference calls. Be sure the firm has low debts and can easily pay expenses from revenue in a short period of time. Pay regular attention to the growth rates of debt and sales. Lastly, compare the firm’s correlation to the commodity and equity markets in up and down economies. You’re investing in commodities to diversify risks, not increase equity market exposure.
Commodity investing through actively managed or passively managed funds is also possible. Funds can invest in commodities in equities of commodity producers, bonds of commodity producers, and potentially futures. Mutual funds cannot trade futures, since regulation prevents them from handling derivatives. Hedge funds which actively trade commodity investments will make enthusiastic use of futures. Exchange traded funds (ETFs) are passively managed funds which are purchased and sold like shares. They usually have lower costs than mutual funds. These funds may directly track commodity indexes and can be useful for following commodities markets.
ETFs trade exactly like shares. You can buy them long or short sell them, which allow you to profit from falls across an index targeted by the fund. You can also use inverse ETFs, which are exchange traded funds for those who cannot short funds. As the underlying index or assets rise, the ETF falls in value. As the underlying index or assets fall, the ETF rises in value.
Selecting specific index tracking ETFs will allow you to select your risks exposures. Commodity indexes are essentially groups of commodity related investments tracked as a group. A base value for the group is selected, and their performance is tracked in relation to the base value. Mutual funds and Exchange traded funds can imitate indexes by purchasing investments in the index and balancing them equally within the fund. They add new investments added by the index and remove investments removed by the index. This allows them to track index performance. Indexes may be available for commodities, firms which produce commodities, and commodity futures.
Futures are the most common way to participate in commodity investing. Futures secure a distant price of a bundle of commodities sold today. If the market price is higher than the secured future price, the buyer earns a profit and the seller earns a loss. If the market price is lower than the secured future price, the seller earns a profit and the buyer earns a loss.
Futures trade on commodity & futures exchanges. Trading successfully requires full comprehension of futures and transacting contracts. You will need to register a trading account with a futures exchange, future commission merchant, commodity trading advisor, or commodity pool operator. An advisor will trade your account exclusively. A commodity pool operator will combine your funds with other investor’s accounts to purchase larger batches of commodity futures. All investors in the pool have equal percentage gains and losses based on their team’s success. The combined purchasing power results in advantageous bulk pricing. The commodity pool operator manages the pool.
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