How to Invest in Commodities Like a Pro: Simple Steps for Smart Returns

Commodities rank among the oldest forms of investment in human history.

Learning to invest in commodities could be more relevant now than ever before. These tangible assets have proven their worth during market uncertainties. From energy products like oil and gas to agricultural goods like corn and wheat, to precious metals like gold and silver – each offers unique benefits. Commodities’ advantages are clear: they maintain a low to negative correlation with stocks and bonds and perform strongly when inflation rises.

What makes commodities fascinating is their direct connection to real-life events. Natural disasters and geopolitical changes affect their prices, which fluctuate based on simple supply and just need principles. This makes them a powerful tool to broaden beyond traditional investments.

Want to add commodities to your investment strategy? Let’s explore everything you need to know to begin your journey.

Understanding Commodity Basics for Beginners

_{Image Source: Insurance & Finance Companies}

Commodities are the foundations of our global economy. These raw materials and resources help create everything from the food on your table to the gasoline in your car. You can exchange these physical, standardized goods no matter who produces them.

What are commodities and why invest in them?

Commodities are simple resources that help produce other goods and services instead of finished products. Their unique feature is uniformity among producers – gold from one mine matches gold from another.

Investors usually add commodities to their portfolios, like stocks, crypto or real estate, for three main reasons:

• First, commodities work well as a hedge against inflation. Their values typically rise with prices, which helps protect your purchasing power. Data shows commodities have matched closely with the U.S. Consumer Price Index from 1990 to 2024.
• Second, commodities give you genuine diversification. They don’t follow the same patterns as stocks and bonds. The Bloomberg Commodity Index returns showed little connection to U.S. equities and almost none to global bonds.
• Third, commodities can bring good returns when supply and demand move in favorable ways.

Major types of commodities to think over

Commodities split into two main categories:

1. Hard commodities: These come from mining or extraction and include:
   • Energy products (oil, natural gas, coal)
   • Precious metals (gold, silver, platinum)
   • Industrial metals (copper, aluminum, iron)
2. Soft commodities: These grow or come from farming and include:
   • Agricultural products (wheat, corn, soybeans, coffee)
   • Livestock (cattle, hogs)

How commodity markets are different from stock markets

Commodity markets work quite differently from stock markets in several key ways:

Commodity markets exist to trade physical resources, while stock markets deal with company ownership. Commodity prices react to supply-demand dynamics, seasons, and inflation. Stocks respond to company earnings and business prospects.

Commodity prices swing more widely because they react strongly to world events and supply problems. Unlike stocks, commodities don’t pay dividends – you make money only when prices go up.

Rules and oversight are different too. The Chicago Mercantile Exchange (CME) and New York Mercantile Exchange (NYMEX) follow different regulations than stock exchanges.

These key differences help new investors choose the right strategies for commodity investing.

Choosing Your Commodity Investment Method

_{Image Source: Quantified Strategies}

The commodity markets offer several ways to invest, each with its own benefits and requirements. The right investment method is vital to your success in this asset class.

Direct ownership of physical commodities

We used precious metals like gold and silver for physical commodity ownership. These tangible assets protect against inflation and give you security when markets become volatile. Storage costs, insurance needs, and selling challenges can make this complicated. Most commodities beyond precious metals are impractical to own because of storage limits and spoilage risks.

Commodity ETFs and mutual funds

ETFs and mutual funds are a great way to get started with commodity investments. These vehicles come in several forms:

• Physically-backed funds: These ETFs directly hold commodities like gold or silver in secure vaults
• Futures-based funds: These use derivative contracts to track commodity prices
• Equity-based funds: These invest in companies that produce commodities

Much of what makes commodity funds attractive is how easy they are to buy through standard brokerage accounts with small amounts of money.

Commodity stocks and company shares

Companies that produce, process, or distribute commodities give you indirect exposure to commodity markets. These stocks tend to move with commodity prices and pay dividends that physical commodities can’t. Mining companies, energy producers, and agricultural businesses fit this category. Note that commodity stocks often relate more to the broader stock market than commodity prices.

Futures contracts and options

Futures contracts let you agree to buy or sell specific amounts of commodities at set future prices. You can control large positions with relatively small amounts of money. The risks are substantial though – you could lose more than your original investment. This strategy needs deep market knowledge and works best for experienced investors or those ready to learn specialized trading skills.

Your investment goals, risk tolerance, and commodity market expertise will guide your choice.

Setting Up Your First Commodity Investment

You’ve got the basics down, so let’s get your first commodity investment set up. The steps are simple to follow.

Opening the right brokerage account

A commodities investment account works just like a regular brokerage account. Standard brokerage accounts work well to invest in commodity ETFs or stocks. You’ll need to provide personal information, financial details and answer simple questions about your investment experience.

Many online brokerages don’t require minimum deposits. However, futures trading usually needs a few thousand dollars upfront. Gold IRA investments need higher minimum deposits because an ounce of gold can cost over $100,000.

The best broker should have excellent customer support, reasonable fees, strong security and useful research tools. Top platforms give you up-to-the-minute data, easy-to-use interfaces and detailed charting features.

Starting with commodity ETFs for beginners

Exchange-traded funds (ETFs) give newcomers the easiest way to start commodity investing. These funds come in three main types:

• Physically-backed funds that directly hold commodities like gold in secure vaults
• Futures-based funds that use derivative contracts to track commodity prices
• Equity-based funds that invest in companies producing commodities

ETFs have major advantages: they’re easy to buy and sell, show clear holdings and performance, and remove storage hassles for physical commodities. They also let you spread risk across multiple commodities or sectors with one investment.

Building a watchlist of potential investments

A good watchlist helps you track commodity investments. Your personal list lets you spot opportunities without searching endlessly for asset information.

Here’s how to create an effective watchlist:

1. Keep each list between 5-10 assets to stay focused
2. Group items based on your investment strategy (e.g., “Energy Commodities” or “Precious Metals”)
3. Set price alerts for important market moves
4. Update your list by removing outdated positions regularly

A well-kept watchlist saves time and helps spot market opportunities quickly by cutting through market noise and focusing on assets that match your strategy.

Creating a Balanced Commodity Portfolio

Building a balanced commodity portfolio takes smart planning and requires careful attention to several vital factors. The right strategy can boost your returns and provide significant diversification benefits.

Determining your ideal allocation percentage

Financial experts typically suggest putting 5-10% of your investment portfolio in commodities. This moderate allocation helps you diversify without too much exposure to commodity volatility. Your allocation might need to be smaller if you don’t handle risk well.

Higher commodity allocations beyond standard recommendations might make sense during high inflation or uncertain market conditions. The best percentage changes based on inflation levels and economic conditions.

Your allocation decisions should factor in whether you calculate returns in nominal or real terms. The benefits of commodity allocation look much better when you focus on real (inflation-adjusted) returns instead of nominal returns.

Diversifying across different commodity types

Commodity sectors show remarkably low correlations with each other, which makes sector diversification valuable. The correlation between commodity sectors runs lower than equity or fixed income sectors, so sector diversification helps even more.

A balanced approach should spread your commodity investments across:

• Energy commodities – oil, natural gas
• Precious metals – gold, silver
• Agricultural products – grains, livestock
• Industrial metals – copper, aluminum

Gold needs special attention because it serves as an excellent buffer against stock market volatility.

Balancing commodities with traditional investments

The low or negative correlations between commodities, stocks and bonds make commodities excellent portfolio diversifiers. They can help lower your portfolio’s overall risk and improve return consistency over time.

This benefit becomes extra important during inflation spikes when commodities often provide substantial protection. Research shows commodities have maintained a beta to inflation of about 6 to 10 over the past three decades. Even a small position in commodities can give your portfolio significant inflation protection.

Your implementation method matters greatly. The choice between physically-backed funds, futures-based funds, or commodity stocks can affect your results substantially. Each approach brings different risk-return profiles that should match your investment goals.

Conclusion

Commodities serve as effective tools for smart investors who want portfolio diversification and protection against inflation. A closer look at commodity investing shows how these tangible assets provide unique benefits during uncertain market conditions.

The beauty of commodity investing lies in its simplicity. Investors can choose ETFs for ease of use, commodity stocks to earn dividends, or futures to access markets directly. Each approach aligns with different investment goals and expertise levels.

Commodities work best when they’re part of a well-balanced investment plan. A modest 5-10% allocation helps you capture the benefits while keeping risks in check. Your allocation can shift based on market conditions and personal goals as your expertise grows.

Patience and understanding pave the way to success in commodity investing. The best strategy is to begin with small positions and build them up as you learn more about market dynamics. This approach will help create a stronger portfolio that can weather market uncertainties better.

FAQs