Move over Bitcoin. There’s a new and exciting trade in town: commodities.
Fueled by multiple factors, including a vaccine-driven turnaround in global growth and increasing inflation concerns, the broad-based commodities rally is on white-hot tear.
The Invesco DB Commodity Index Tracking Fund — which looks to achieve diversified commodity exposure — is up more than 50% over the past year and holding steady.
Bitcoin, on the other hand, has had brutal week, falling by as much 17% on Tuesday, now down about 30% from its 52-week highs set in April.
Let's take a quick look at the basics of commodities investing and how investors can quickly get into the game.
What is commodities investing?
Commodities are the raw materials at the foundation of everyday life: Things that can be mined, drilled or grown and then used to produce the goods we use.
Whether we’re sipping coffee, putting on a new T-shirt or pumping gas into our cars, commodities make it all possible. Which means people’s day-to-day consumption habits have a significant impact on the prices of commodities.
From an investor’s perspective, commodities trading is simply the act of buying and selling these raw materials to either earn a profit or hedge risk.
Why invest in commodities?
While investors are always hunting for bigger returns, there are other good reasons to invest in commodities:
Reason No. 1: Diversification
Diversification is probably the single best reason to add commodities to your portfolio.
Why? Because commodities tend to have very little correlation with more traditional asset classes.
Historical trading patterns have shown stocks and bonds tend to move in tandem with each other. That can make it difficult to guard against a downturn if those are the only groups you’re invested in.
But it’s different with commodities.
Commodities are primarily influenced by the supply and demand dynamics occurring in their individual markets.
That means commodities don’t necessarily move in lockstep with other financial assets; and in many cases, they can move in the opposite direction of stocks and bonds.
So, allocating a portion of your portfolio to commodities can give you a cushion of protection against a decline on Wall Street.
Reason #2: Inflation Hedge
Investing in commodities remains one of the most reliable ways to guard against the ravages of inflation. That’s because as inflation rises, the price of raw materials increases right along with it.
Legendary investor Warren Buffett recently touched on this phenomenon when discussing his company’s current housing operations.
“The costs are just up, up, up,” he said at Berkshire Hathaway’s annual shareholders’ meeting. “Steel costs, you know, just every day they’re going up.”
Commodities have historically performed well during periods of high inflation, even as stocks and bonds declined.
How to Invest In Commodities
There are several ways to invest in commodities, including just buying and owning them directly.
If you want to invest in gold, for example, purchasing a few gold coins from a local dealer is easy enough.
The difficulty lies in owning unwieldy commodities like natural gas or livestock. Very few people have the space to store hundreds of barrels of oil or to house a herd of cattle.
Thankfully, there are practical methods for average investors to invest in commodities.
Commodity ETFs
Commodity exchange-traded funds (ETFs) offer the simplest way to gain exposure without having to directly own the commodity.
Some commodity ETFs let you zero in on a single commodity, while others group them together for broad-based exposure.
For instance, the SPDR Gold Shares ETF is designed to move in lockstep with gold prices, giving you a “pure” way to invest in the yellow metal.
Meanwhile, Invesco’s previously mentioned Commodity Index Tracking Fund provides exposure to 14 of the most heavily traded physical commodities, including crude oil, gasoline, corn, gold and soybeans.
ETFs typically have very low management fees, and you save even more by buying them through a zero-commission investing app.
Commodity stocks
Another easy way to invest in commodities is by owning the companies that produce them.
For instance, energy blue chips like BP, Exxon Mobil and Chevron are a good way to gain exposure to oil and natural gas. Agricultural stocks such as Mosaic and Tyson Foods let you invest in fertilizers and livestock, respectively. Mining giants like BHP, Rio Tinto and Vale all provide access to a wide variety of metals.
And thanks to a new investment platform, you can actually buy stakes in U.S. farms. You'll get a cut from both the leasing fees and crop sales, providing you with a cash income while the value of the asset increases.
A word of caution: Commodity stocks don’t always track their underlying commodities perfectly because other business-specific factors come into play – like the company’s financials, the quality of its management team and its long-term production prospects.
And at any given time, any one of those factors can have a greater impact on the stock price than the underlying commodity.
Making the call
With inflation continuing to heat up, it doesn’t look as if the rally in commodities will slow anytime soon. But remember this: Commodities investing is always a high-risk, high-reward proposition, regardless of when, what and how.
For more risk-averse investors, focusing on real assets that produce cold, hard cash might be a better place to start.
For instance, some popular investing services make it possible to lock in a steady rental income stream by investing in premium real estate properties — from commercial developments in LA to residential buildings in NYC.
You’ll gain exposure to high-end properties that big-time real estate moguls usually have access to, and you’ll receive regular payouts in the form of quarterly dividend distributions.