Commodities have been around almost as long as human civilisation, with evidence that people used to trade rice as much as six millennia ago and that clay coins were used to buy livestock in Sumerian society around 4,500 BC.
As of the 21st century, commodities are at the very heart of global trade, and individuals with modest capital to invest now have better access than ever to commodities thanks to the ability to invest in commodities online.
They are also a useful component in a risk-averse investment portfolio, as commodities can be used to diversify a portfolio and to hedge against inflation risks, all of which reduces the overall risk of your investment strategy.
Four main types of commodities
The four main categories of commodities include:
- Agriculture: Livestock, food crops and industrial crops like timber and wool.
- Energy: Coal, crude oil, natural gas, uranium, electricity etc.
- Metals: Base metals (aluminium, steel, zinc etc.) and precious metals (gold, silver, palladium, platinum).
- Environment: Trading in carbon emissions, renewable energy certificates etc.
Much of the parlance used when discussing cryptocurrencies is also commodities-related, such as the practice of ‘mining’ coins and the parallels between virtual currencies and real-world precious metals like gold.
However, while investors may think of cryptocurrencies as virtual commodities, they are often regulated similarly to shares by both the US SEC and the Swiss FINMA.
So is Bitcoin a commodity? Not technically, although many people think of cryptocurrencies as a fifth category, or as a virtual extension of precious metals in many ways.
Reasons to consider commodities
We’ve touched on some of the benefits of trading in commodities above, but let’s look in more detail.
By diversifying your portfolio, commodities can reduce overall volatility because these investments are more loosely correlated with the value of other asset classes.
Because commodities have an intrinsic value that is not linked to currency, they are often seen as a store of value during periods of high inflation when currencies fall.
Commodity prices can show substantial swings, meaning significant gains can be made if you can bear the higher level of volatility.
Commodities are physical materials and because of this they have intrinsic value – so when markets are turbulent, commodities are often seen as a safe haven for investment.
What is a commodity CFD?
A CFD is a Contract For Difference, essentially a promise to pay the capital gain on the value of a commodity, and investors can purchase these promissory notes rather than buying the physical commodity.
In this way you are trading in commodities futures rather than on the current value of the commodity – and in theory when you purchase a CFD you are promising to take delivery of the physical commodity itself at some future point.
Because of this, the major commodity CFDs will often lose value substantially in the final days before they expire – the theoretical ‘delivery date’ – as investors move their money away into vehicles with a longer remaining shelf life.
There can also be large swings in price throughout the lifetime of a CFD, and while this volatility creates opportunities for significant gains, it can also be unpredictable, leading to large losses if you are not careful.
Not all commodity investments are CFDs – there are other ways to trade on commodity futures as well as individual company stocks and ETFs with a commodities focus – so whatever your investment strategy, there is likely to be a vehicle that suits your portfolio.
Buying physical commodities
CFDs are a way to invest in commodities without taking delivery, but there are also ways of buying physical commodities where you receive the goods themselves and resell them at a later date, hopefully at a profit.
Examples include physical gold in all its forms, as well as alternative investments like fine wine, where you may store the bottles in your own cellar or at a specialist third-party wine storage facility under controlled environmental conditions.
This has advantages and disadvantages – by receiving the physical goods, you can keep their intrinsic value at hand until prices rise, potentially riding out any short to medium-term downturn.
At the same time, there may be costs associated with storage, as well as the inherent physical footprint of needing somewhere to put the goods – and incorrect storage, especially of a commodity like wine, could ruin its value.
Major commodities markets
Some of the leading commodities exchanges are around 150 years old and based in major cities all over the world, including:
London Metals Exchange
Founded in 1877 and focusing mainly on base metals.
A relative newcomer, founded in 2000 and initially focused on energy markets.
Chicago Mercantile Exchange
The CME started with a focus on dairy products in 1898. It now offers a diverse range of futures and options and in 2007-08 acquired both the Chicago Board of Trade (founded 1848) and the New York Mercantile Exchange (founded 1882).
How to predict rising commodity prices
Finally, let’s take a look at some of the factors that predict rising commodity prices – and again, remember commodities are physical goods, and so their value is subject to some of the usual driving forces of physical trade.
Scarcity of supply will generally drive value higher, while abundance will drive prices down. This is useful for commodities that are no longer being produced, such as a specific vintage of wine, where you know supply will only decrease over time.
Demand has the opposite effect – high demand is linked with high prices, and vice versa. This is especially true of emerging markets, where very high demand can come from a completely new source and directly impact on commodity prices.
Sociopolitical issues can also have an effect, for example a shortage of skilled labour, or international disputes that disrupt supply. Probably the most familiar example of this to many people is oil prices, which can vary widely depending on politics and instability in the oil-producing countries.
Currencies – particularly the US dollar, which is used to value commodities – can impact on the real-terms gains made. A strong dollar is generally bad news for selling commodities, while weakness in the US currency can increase the gains made.
And finally, very high demand for a particular commodity can lead to value sprawl, where high prices drive buyers into neighbouring materials – for example, when copper is very high, industrial customers may look to aluminium instead.
This leakage of value can be useful for investors by buying into the lower-priced commodity when it is about to rise, rather than investing in the higher-priced material at its peak.
Disclaimer: The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.