Commodities usually involves high costs of storage and procurement. For this reason, investors have relied on futures or commodities firms to obtain commodities exposure. With the introduction of commodities ETF, there is renewed interests. ETFs provide cheap and transparent way to invest in commodities futures.
Factors affecting commodities comprise weather, geopolitical developments, supply constraints in physical production, unanticipated increases in demand as a result of prosperity in emerging markets, and incidents that create political or economic turmoil.
Recent crisis have shaken investor’s confidence in equities. This motivate investors to explore alternative investments in commodities. What are some ways an investor can invest in commodities?
Exchange Traded Funds provide the cheapest way to buy commodities exposure. These ETF track major commodities index
Exchange Traded Notes track non interest paying debt and the credit risks of commodities contracts. Payoff to the ETN depends on the counterparty risk of the futures issuer.
Unit trusts have higher fees than ETFs as they typically employ discretionary management methods to invest in commodities or companies in the businesses related to commodities.
An investor can also trade derivative contracts such as futures and swaps directly. The most direct way of investing in commodities is to buy the physical commodities incurring storage costs. One of the most indirect ways to gain exposure to commodities is to buy equities of related businesses.
Commodities have unique characteristics. Metals are seen as safe haven for investors and demand can be driven by the stability of the value of money. Soft commodities such as grain, crops and coffee generally react well to extraordinary detrimental events.
Agriculture sector is less dependent on economic conditions and more dependent on factors such as global weather. The low correlation (even lower than bonds) is an important tool for portfolio allocation. Commodity prices can also hedge inflation.
For long term investors, commodities will be a strategic allocation tool for the portfolio due to the low correlation with equities. For short term tactical allocations, commodities rise when inflationary pressures increase.