Metals, fossil fuels and grains– commodities in everyday use can also be in your portfolio. Learn about different commodities, their risks and strategies to invest in them.
There are many options – buy physical commodities like bullion, invest in a commodity ETF or mutual fund, buy stocks of companies that produce commodities, buy ETFs or funds investing in commodity producers or invest in commodity derivatives. You need a brokerage account to trade in stocks, mutual funds or ETFs, and derivatives. Brokers may have minimum capital requirements for commodity futures trading.
Fiat money is currency that is legal tender not backed by any physical commodity like gold. The earliest U.S. currency was pegged to gold and silver while the first fiat came during the Civil War. The gold standard came back in 1879 but was abandoned after the Great Depression in 1933. The gold standard was followed by the Bretton Woods system which eventually collapsed and gold convertibility of U.S. dollars ended in 1971.
You can typically classify commodities traded in the U.S. in three broad categories – agricultural, energy and metals. Agricultural commodities include corn, soybeans, lean hogs etc. Trading energy commodities includes instruments based on or investing in crude and natural gas products. You can trade metals such as gold, silver, platinum and copper among others as well.
A commodity broker places commodity trades for their clients. It can also refer to a brokerage firm that handles commodity trades. For registration purposes, brokerage firms are designated as introducing brokers (IB) or futures commission merchants (FCM). Individuals are designated as associated persons (AP).
To start trading commodities online, you’ll first need to set up a brokerage account. The next step would be to fund this account. Then decide what type of investment you’re making – commodity ETFs or derivatives. You’d need special approval from your brokerage to trade in commodity futures. Enter your trade size and place the order. Once the order is placed, monitor your bet and manage risks.
Water is an essential commodity but with climate change there are increasing risks or floods and droughts. You can invest in water by purchasing stocks of water utility or water treatment companies such as American States Water Co. or Essential Utilities Inc. You could also invest in water ETFs such as Invesco Water Resources ETF (PHO). Water scarcity in California has also led to creation of Nasdaq Veles California Water Index futures.
You can’t really buy physical barrels of crude oil. You could, however, invest in stocks or debt of oil producers such as ExxonMobil or Chevron. You could also purchase mutual funds investing in the oil sector. Crude oil ETFs or ETNs can offer regular or leveraged exposure to the commodity. You could also trade crude oil futures, if you understand the market and have the risk appetite to do so.
Contango describes a market condition when the prices of a certain commodity are higher in the distant future than in the near future.
A commodity broker is an individual broker or brokerage firm that handles commodity trades on behalf of its clients.
The spot price is the current price you’ll pay to acquire a stock, bond, commodity, or currency immediately. However, spot price is most frequently used in commodity trading for several reasons. It’s the price you’ll likely see quoted when you’re considering buying an asset.
Basis risk is an important concept in hedging. It's the price differential between the futures price and the physical commodity.
A calendar spread is an investment strategy for derivative contracts in which the investor buys and sells a derivative contract at the same time and same strike price, but for slightly different expiration dates.
Bullion is the pure or nearly pure form of a precious metal such as gold that is valued for its metal content. Bullion can be purchased through precious metals dealers, both online and in brick-and-mortar stores.
Commodities futures contracts are agreements to buy or sell a raw material at a specific date in the future at a particular price. The contract is for a set amount. It specifies when the seller will deliver the asset. It also sets the price. Some contracts allow a cash settlement instead of delivery.
Crude oil is a liquid fuel source located underground and extracted through drilling. Oil is used for transportation, heating and electricity generation, varied petroleum products, and plastics.
Backwardation occurs when the prices of a commodity are higher in immediate months than they are in the future.
Commodity ETFs consist of stocks involved in the commodity or futures and derivative contracts that track the prices of the underlying commodities. In some cases, the ETFs track commodity indexes.
Futures represent an agreement to buy or sell a specific quantity of a stock, security, or commodity at a set price on a certain date in the future. Short for "futures contracts," these agreements are legally binding. They must be fulfilled either by physical delivery or cash settlement.
This type of futures spread involves buying and selling different but related commodities. The commodities tend to be correlated, but there may be reasons why one commodity could be stronger than the other
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