How to Invest in Commodities
How to Invest in Commodities. Everything you need to know on investing in commodities and why invest in commodities.
What are Commodities
What is a commodity? Commodities are basic resources that are used every day. They include food products such as sugar and corn, basic products such as steel and aluminum, energy-related resources such as crude oil and natural gas, and precious metals such as gold and silver.
Spot Price of a Commodity
The spot price of a commodity is the price that the commodity is selling for today.
Futures Price of a Commodity
Futures are derivatives – that is, they derive their value from the value of an underlying asset.
A futures price of a commodity is a contract for delivery of a set amount of the commodity at a specific time in the future. As it is not practical to trade physical commodities, most people instead trade futures contracts.
Commodities Futures Contracts
A futures contract is an agreement to buy or sell a fixed amount of a commodity at a fixed date in the future and at a fixed price. What determines the price of a futures contract? Two main factors: today’s spot price for the commodity, and the anticipated spot price on the future delivery date.
The spot price of the commodity today is the most important factor that affects the price of a futures contract. Other factors that affect the price of the futures contract: supply and demand factors, interest rates over time.
Commodity Research Bureau (CRB) Spot Market Price Index
This index is a comprehensive measure of the price movements of 22 actively traded commodities: butter, hides, steel scrap, wool tops, burlap, copper scrap, cotton, lead scrap, hogs, lard, rosin, tallow, cocoa beans, corn, steers, sugar, wheat, print cloth, rubber, tin zinc, and energy resources.
Why Invest in Commodities
How to invest in commodities? And why? The main benefit of investing in commodities is that they are very lowly correlated with other asset classes. They thus fit within the asset allocation Modern Portfolio Theory well.
However, investing in commodities as an asset class is generally not advisable, as commodity total return indexes have historically low returns. The risk/reward ratio is far from desirable.