How to invest in commodities

Commodities have fascinated investors for decades – but what do you need to know about them, and can they benefit your overall portfolio?

Here we explain the different types of commodities, what affects their prices, the various pros and cons, and how you can invest in this sector.

What are commodities?

Commodities are raw materials that are used to create products that are either eaten or used by consumers around the world. The area is generally divided into three main categories: agriculture, energy and metals. Each will have its own performance drivers.

Agriculture includes sugar, cocoa, coffee, wheat, oats, and corn, while energy encompasses crude oil, gasoline and natural gas.

Metals, meanwhile, can be either industrial or precious, with the list including gold, silver, platinum and copper amongst others. This illustrates the scale of the market.

What affects commodity valuations?

It’s all down to supply and demand. Generally, prices rise when demand is high and supply is limited. Conversely, it falls when demand drops or there is an oversupply.

Of course, these situations can be influenced by various factors. The success – or otherwise – of individual crops, political instability, and global economic issues can play a part.

Russia’s invasion of Ukraine in early 2022 is a prime example. When people feared oil and gas supplies would be disrupted, prices started to climb. As one of the world’s largest exporters of grain, the invasion of Ukraine also pushed up global food prices.

From an investor’s standpoint, the key to success is being on the right side of such movements, although this is obviously easier said than done.

Why should you consider investing in commodities?

The main reason is diversification. Commodities are, by their very nature, real assets and their values can be affected in different ways to stocks. For example, commodities are one of a relative handful of asset classes that tend to benefit from rising inflation, according to PIMCO.

“As demand for goods and services increases, the price of those goods and services usually rises as well, as do the prices of the commodities used to produce those goods and services,” it noted.

As commodity prices generally rise when inflation is increasing, exposure to commodities can potentially provide investors with a hedge against inflation.

Potential downsides of investing in commodities

The sector can be hugely volatile. This means the value of your portfolio can soar rapidly or endure substantial losses. If you hate uncertainty, commodities won’t be ideal.

It’s an area that can also be adversely affected by weather, economic problems, political uncertainty, and even speculation. There are a lot of moving parts to this story.

Are commodities for you?

This will depend on your investment goals and attitude to risk. If you’re looking for an element of portfolio diversification, then buying some commodity exposure could be a wise move.

Broadly speaking, commodities have a part to play in a balanced portfolio for the very reason that they provide a different return dynamic to equities and bonds.

How to get exposure to commodities

There are a number of ways to access the sector. The first is through buying actual raw commodities, such as precious metal gold bullion. Another option is through futures contracts or exchanged traded products that track a specific index. However, these can be complicated and volatile.

An alternative is opting for investment funds that have exposure to the area, although this usually means companies involved in the sector, rather than the commodities themselves.

This means you may still have to endure stock market volatility in the short term.

Potential funds can be found in the IA Commodities and Natural Resources sector, which is for portfolios with at least 80% of their assets invested in related equities.

FundCalibre Elite Rated funds in this sector currently include Ninety One Global Gold, Jupiter Gold & Silver, BlackRock World Mining investment trust and TB Amati Strategic Metals.

Of course, you can also buy shares in individual companies. For example, you could invest in oil giants such as BP or Shell. However, this can be a risky option. Only having a handful of such investments can leave you vulnerable, as you’ll be reliant on just those names to perform.

_{Photo by Jingming Pan on Unsplash}