Commodities are raw materials that manufacturers further process to create various intermediates and finished products. Commodities include many raw materials from agricultural commodities, crude oil, precious metals like gold, silver etc.
The main peculiarity of commodities is that they are subject to commodity cycles that follow the business cycles in the economy. The commodity’s price settles where the demand and supply for the commodity are in equilibrium.
Why should we invest in commodities?
Portfolio diversification is the key to long term wealth maximisation. We must diversify our portfolio allocation among different asset classes, industry sectors, geographies and securities to maximise our return and minimise our risk. This is because asset classes like commodities exhibit a low correlation with asset classes like equities.
As we know, equity markets are at their near peak levels. Geopolitical factors like the Russian-Ukraine war, sharp increases in global commodity prices, monetary policy tightening and rising interest rate trajectory lead to a lot of volatility in equity markets.
In such a case, it would be prudent to partially diversify into commodities through commodities trading on your commodity trading platform.
Commodities are classified into hard commodities and soft commodities:-
Hard commodities:
- Energy: Crude oil, ATF, coal and natural gas
- Metals: Aluminium, Copper, Zinc
- Precious Metals: Gold, Silver etc.
Soft Commodities:
- Agricultural commodities: wheat, corn, Soybeans
- Meat products: Pork bellies, Cattle
- Wood products: Paper, lumber, bio-energy
Avenues available for commodities trading
Futures and options contracts in different commodities:
Futures and options are derivative products that multiply and magnify the profits and losses from trades. If you are a beginner in stock markets and not experienced in derivatives or commodities and commodity trades, this is not a suitable avenue for you.
Physical commodities:
Physical commodities are bulky and cumbersome. They are not easy to trade. They require warehousing and logistics to transport from the purchaser to the seller and do not provide the facility to trade efficiently. When you buy gold and silver for auspicious occasions, you are, in effect, trading in precious metals as a commodity.
Stocks of commodity companies and Exchange Traded Funds:
Stocks of commodity companies are influenced by the underlying trends in the commodities and trends in the equity markets. If you want to take advantage of a pure commodity play, the best way to trade commodities is through exchange-traded funds (ETFs) managed by an experienced commodity manager.
This way, you, as a passive investor, can benefit from the underlying commodity movements without needing experience and market knowledge about commodities trading.
Commodity ETFs can track multiple commodities or a single commodity. You can choose whether you want to get exposure to multiple commodities or whether you want to benefit from market movements in a single commodity by choosing an appropriate ETF.
Some popular commodity ETFs available in the Indian market include:
The two main types of commodity ETFs available in India are Gold and Silver ETFs listed on the Bombay Stock Exchange and National Stock Exchange. Other types of commodity ETFs are available in overseas markets.
Key Takeaways
The best way to do commodity trading is through ETFs. They are flexible, leverage the underlying forces in the commodities market, provide greater liquidity, enjoy low expense ratios, and are friendly to your budget, flexible and tax-efficient. They are the easiest way for you to introduce diversification into your portfolio.
