Investing in Commodities

Today we continue with the investing for beginners series. You can check the previous posts

What are stocks and how to value them, 

How does Currency Trading Work, 

How are Currencies Traded

 

If you are a regular around here, you will know that most of my money is invested in commodities. Yes siree. I’m a big proponent of the secular commodity bull market that’s happening right now. But before I explain exactly what I’m doing, here are the basics regarding investing in commodities.

What are Commodities

Commodities are standardized raw materials. The difference between a standardized raw material and a non-standardized raw material is that only a standardized raw material can be bought and sold by investors. You and I can buy or sell ounces of gold, barrels of oil, bushels of cotton, etc. However, we cannot buy or sell a raw material like cabbage because no two cabbages are exactly alike, while all ounces of gold are exactly the same (assuming they’re of .999 purity).

Thus, the commodity market is a very big market (larger than stocks but smaller than currencies). For each raw material, there is an individual market:

1. Oil, measured in dollars per barrel.
2. Gold, measured in dollars per ounce
3. Silver, measured in dollars per ounce
4. Copper, measured in dollars per tonne
5. Cotton, measured in dollars per bushel

And so on.

Commodities are Traded on the Futures Market

Stocks are traded on the stock exchanges, such as the New York Stock Exchange (NYSE). But in order to buy or sell commodities such as oil and gold, you do not just “buy” oil and gold stocks. You must buy or sell commodities “futures contracts”.

Now futures contracts are a complicated investment vehicle that I’m not going to get into in this specific post. All you need to know about futures contracts are that:

1. They are very large. A futures contract typically involves at least $100,000 per single contract. That means if you only have $50,000 in your investment account, you cannot even buy 1 contract in eg gold.
2. Futures contracts complicate things. You cannot just buy 100 ounces of gold (unless you buy from your local bullion dealer, who will charge you a massive premium). In the old days, the only way to invest in commodities was to buy futures contracts which included delivery dates, future expiration dates, premiums, and a whole bunch of crap that’s just too damn complicated.

As you can see, futures contracts are very annoying. That’s why in the old days (20 years ago), if you wanted to buy e.g. gold, you couldn’t buy it at the spot price (the price listed on the exchange!). That’s why many people did not invest in commodities – they couldn’t even if they wanted to!

But all this changed 20 years ago with the introduction of ETF’s….

Commodity ETF’s.

These are beautiful investment vehicles that allow you and I to “invest” in commodities such as oil, gold, silver, etc. An ETF is essentially a stock that tries to match the underlying commodity as closely as possible. Let’s take GLD as an example (the gold ETF). If gold prices rise 5% in one day, GLD will also rise 5%. If gold prices fall 3.1% the next day, GLD will also fall 3.1%.

Thus, when you are buying an ETF, you make the exact same profits or losses as if you were to buy the underlying commodity in the first place! That’s why whenever I buy or sell commodities, I don’t buy/sell futures contracts. I always buy/sell commodity ETF’s. It avoids the hassle regarding futures contracts

Look at What Other Investors & Funds & Banks are Buying or Selling

There is something known as the COT Report created by the U.S. Commodity Futures Trading Commission (government agency) that’s updated once every week on Friday. This COT Report is absolutely awesome, and no other markets (stocks nor currencies) has it.

What the COT Report does is that it displays how many people are long (bullish) or short (bearish) on each individual commodity. Thus, there is a seperate COT Report for oil, gold, silver, copper, cotton, etc. Each week, the COT Report is updated to reflect the change in bullish positions and the change in bearish positions.

Thus, the COT Report essentially shows you what every one else is buying and selling!

 

You can trade commodities easily on forex platforms, those are usually pretty intuitive for beginners and you can even download their apps on Google Play to follow your investments on your phone.