- Commodities are basic goods such as wheat, gold, oil and cattle.
- Commodities can help diversify an investment portfolio but might not be suitable for all investors. It’s important to understand the products and markets before investing.
- Investing in commodities can involve getting direct exposure to a commodity—like holding an actual, physical good—or investing in commodity futures contracts, which are legally binding agreements to buy or sell a particular commodity at a future date for a fixed price and quantity.
- Commodity mutual funds and exchange-traded products (ETPs) can provide another, more accessible way to invest in or get exposure to commodities and commodity-related businesses without having to accommodate such factors as physical delivery or storage.
- Commodity investments might offer leverage, which can amplify the risk of significant gains or losses, and the leveraged or inverse exposure offered by some commodity futures-linked ETPs can pose significant additional risks.
Commodities are the basic goods that make up everyday life. They can include metals such as copper, gold and silver; energy sources such as crude oil and natural gas; agricultural commodities such as wheat and coffee; and livestock and meat products such as pork and cattle. Investing in commodities as an asset class, like equities or fixed income, is a way to potentially add diversification to an investment portfolio.
Investors can gain exposure to this asset class through direct investment in commodities or through commodity futures, as well as through mutual funds and exchange-traded products (ETPs)—including exchange-traded funds (ETFs), exchange-traded notes (ETNs) and ETPs using other structures such as commodity pools.
A direct investment in a commodity provides exposure to the performance of the commodity’s “spot,” or current price, and involves taking immediate delivery of or physically holding the commodity. This approach is less common with retail investors since it can also involve logistics such as transportation and storage, as well as insurance. With retail investors, direct investment in commodities is often in various precious metals such as gold and silver.
Commodity futures are derivative contracts in which the purchaser agrees to buy or sell a specific quantity of a physical commodity at a specified price on a particular date in the future. Derivatives are investments that derive their value from the price of another asset, typically called the underlying asset.
Commodity futures are most often traded by commercial enterprises that depend on commodities for their business activities. For example, your favorite cereal company might buy wheat futures to secure prices, while an airline might purchase energy futures.
Some sophisticated investors might also trade commodity futures, hoping to profit from changes in the price of a futures contract and never owning a contract when it comes due so they don’t have to deal in the physical commodity (such as accepting delivery of 40,000 pounds of cattle).
The Commodity Futures Trading Commission (CFTC) is the federal government agency that regulates the commodity futures and other commodity derivatives. By contrast, security futures are jointly regulated by the CFTC and the Securities and Exchange Commission (SEC).
Anyone who trades futures with the public or gives advice about futures trading must be registered with the National Futures Association (NFA). Before you invest in commodity futures, check to make sure the individual and firm are registered and whether they’re the subject of any disciplinary actions by using the NFA’s Background Affiliation Status Information Center (BASIC). NFA also offers a number of resources for investors to learn more about how the futures market works and the risks involved.
Commodity mutual funds and ETPs offer another avenue to investing in or tracking the performance of commodities and can help investors avoid the challenges or inconveniences of investing directly in physical commodities or futures. These products typically fall into one of two buckets:
- funds or products that invest in or track a wide variety of commodities or indexes and are registered securities that provide legal protections and ongoing disclosure about the investment; or
- commodity-oriented mutual funds and ETFs that focus their investment in securities issued by companies involved in mining, refining or development and other aspects of commodities-related business.
Either way, these products can provide a more accessible or cost-effective way to diversify among different types of commodities.
Some commodity futures-linked ETPs offer “geared” exposure, meaning they’re designed to provide returns that are leveraged (such as two- or three-times) or inverse (such as the opposite or twice the opposite) of the return of the commodity futures they track. This geared exposure is usually for a specific period, like one day or one month, and such products are generally not designed to be held for periods that deviate from that. Given the more volatile nature of some commodities and the additional complexities of the futures market, leveraged or inverse ETPs tracking commodity futures can present investors with heightened risks.
Commodities can add diversification to an investment portfolio and might offer protection against inflation. However, commodity prices can be highly volatile, and investing in commodity futures and related products can carry significant risk. In particular, know what type of exposure your investment offers, and understand how exposure to futures can differ from exposure to the spot price of a commodity. The performance of a futures investment over longer periods can diverge, potentially significantly, from that of the spot price of the same commodity, and geared ETPs can also amplify that divergence.
Be cautious of claims that you can make large profits from trading futures. Although the high degree of leverage in futures can result in large and immediate gains, it can also result in large and immediate losses. As with any financial product, there’s no such thing as a "sure winner."