A beginner's guide to investing in commodities
Commodities are physical assets and include metals such as gold, silver and copper, oil and gas, and so-called ‘soft’ commodities such as wheat, sugar and cocoa beans. ‘Commodities are often referred to as the “fifth” asset class, after the conventional investment asset classes of cash, fixed interest securities, equities and property,’ says Martin Bamford, managing director of IFA Informed Choice.
The sector has little correlation with the stock market and currencies, which means if equity markets fall, then the price of commodities won’t necessarily plummet. Bamford adds: ‘They tend to behave differently from these conventional asset classes, which means they can be very useful for the purposes of diversification within an investment portfolio.’
‘Investment into precious metals has gained significantly greater visibility over the past decade,’ says Russ Koesterich, global chief investment strategist at BlackRock’s exchange traded product (ETP) arm, iShares. ‘While gold has acted as a store of value for thousands of years, the recent performance of precious metals, their diversification benefits and inflationary concerns have restarted the discussion of this investment category among many institutional and private investors.’
Even taking the sell-offs of the past 15 months or so into account, commodity prices have almost tripled over the past 10 years according to the Index Mundi commodity price index, with much of their success being derived from the emerging markets growth story.
How to invest
There are three ways to invest in commodities – either physically, or by buying shares in commodity companies, or indirectly through a fund or an investment trust.
Investing physically means actually buying and holding the asset; it comes with storage problems, but there are several bullion firms offering online gold dealing and safe storage of the asset. Buying physical gold coins also offers an easy way to access the metal. The World Gold Council provides details of reputable companies on its website, so always check there first.
‘Real direct exposure in commodities usually involves buying physical assets, such as gold coins or bars. This can be expensive, with buying and selling costs to consider in addition to the cost of storage and insurance. Investors will also need to ensure they buy the asset at a good price. This can be difficult to achieve, particularly when buying smaller quantities,’ comments Bamford.
One option for accessing other natural resources such as oil and gas is to buy shares in companies such as BP, Royal Dutch Shell or Tullow Oil. The same applies to ‘soft’ commodity companies, although they are less numerous on the UK indices. However, your investment will be subject to movements in the stock market, as well as to changes in the price of the commodity itself.
An investment fund is an easy way to access the sector. They also provide a degree of diversification, as they will typically invest directly in a variety of commodities as well as in production companies.
Passive funds have also risen in popularity over the past few years, with ETPs becoming a viable way to access commodities either indirectly or directly. Equity-based commodity exchange traded funds invest in shares of commodity companies, whereas exchange traded commodities (ETCs) are instruments that track the price of the commodity, or a basket of commodities. They can either be physically backed by holdings of the commodity itself, or may use swaps with other financial institutions to provide the exposure.
However, ETFs only track an index such as oil futures, so there is little room for manoeuvre. ETCs also allow investors to ‘short’ or ‘leverage’ their investment, allowing investors to take bets on the price either falling or rising. Investors should be careful here, as although there are potential gains to be made, there could be huge losses too.
What to be aware of
Commodities can play a useful long-term role for private investors as a portfolio diversifier, inflation hedge and to take a bet on specific industries or regions. However, investors should be aware of whether or not the investment provides exposure to the underlying commodity. In addition, you should look at the rest of your portfolio, as oil and gas companies, for example, already make up a significant proportion of the FTSE 100.
For asset diversification, consider investing in the physical metal or commodity itself, or otherwise spreading risk by investing in a fund. A tracker fund will keep costs lower.