Investing in raw materials and their derivatives
Investing in commodities has become a more complex procedure in recent years as the number of products that are open to commodities investment has increased.
On a basic level, commodities investment means investing in something that can be standardised, such as oil; regardless of which company extracts the oil from the ground and delivers it to where it’s needed, the end product is pretty much the same. In order to be viable as part of the commodities market, it must meet an agreed basic level of quality, but beyond that the definition can be increasingly flexible at the potential to standardise products increases.
As technology enables more and more things to be standardised, commodities have expanded from the traditional list of grain, beef, oil, gold and gas, to include things like mobile phone data or computer components.
Another major change to have impacted commodities is the recent move away from an asset class that demands significant amount of time and expertise to see returns and towards a more straightforward investment process.
Futures contracts are proving to be a popular way to invest in commodities. These contracts mean that two parties make an agreement to buy or sell a specific quantity of a commodity at a certain price on a date in the future.
In some cases, those hedging their bets on future prices are commercial or institutional users of the commodities being traded. By taking a position on a future market change, they are able to reduce their risk should trade take a downturn for example by balancing this off with a healthy return in their commodities investments.
However, individuals also operate in the futures markets primarily as speculators seeking to profit from pricing changes. These participants are purely operating for the financial return up front and are likely to close their position before the contract itself is due, otherwise they would be taking delivery of large amounts of the commodity itself.
Another option for commodities investment is to look at stocks. The main advantage here is that they are significantly less volatile than futures markets. However, investors still need to do their homework and carefully research the stocks they want to buy.
For example, oil companies will allow investors to back different areas of the industry with their investment by differentiating between things like refiners, tanker companies or diversified oil companies.
Market conditions and company-specific factors will have a role to play in commodities stocks, but they do offer an easier and highly liquid investment option.