Tue, Jan 29, 2013

Best Way To Invest In Commodities

Over the last few years commodities have been one of the best-performing investment sectors in the world. Steady economic growth from emerging markets has increased demand for commodities, limited growth in commodity supplies, and the ever-looming threat of inflation have combined to give commodities an even brighter future for commodity investments .

But any investor looking at commodities right now needs to understand the real secrets of investing successfully in commodities before getting into them.

Why? The answer is simple.

Commodity investments have the most profit potential of any mainstream investment. But they also have greater risk than most investors have ever taken on.

So here are the what you need to know to start Investing In Commodities Now .

What is a Commodity?

The definition of a commodity is simple. A commodity is “a mass-produced unspecialized product,” according to Merriam-Webster’s.

That’s true. But more specifically, when investors speak of commodities, they’re referring to the actively traded products around the world. The most common commodities to invest in are mainly raw materials like metals, agriculture products, and energy commodities like oil and gas.

The Reuters/Jefferies CRB (Commodities Resource Board) Index is the best snapshot of all commodities.

The Index is based on the most recent trading price for a basket of the most actively traded 28 commodities in the world. The Index includes the most closely-watched commodities like gold, copper and oil. The index also contains a total of including many less-actively watched ones including cotton, zinc, coffee and corn.

The Reuters/Jefferies CRB Index is one of the best ways to track the performance and price of the overall commodities markets.

Why Invest in Commodities Now?

The CRB Index also shows why there is still time to invest in the commodities run. Just look at the history of the up and down cycles in commodities.

The CRB Index has been around since 1957. Between then and now there have only been two major commodity booms. And throughout history most commodity booms have last between 10 and 20 years.

The second boom we’re in the middle of right now.

The chart below shows the CRB Index over the last 25 years and the cycles of the commodity boom:

Commodity boom and bust periods tend to last far longer than the boom and bust cycles in other economic sectors. The reason is mostly due to large lead times for mine construction (it usually takes at least a decade from when a major mineral deposit is discovered and it is first mined) and high fixed costs of the mines (which increase the capital at risk).

Historical analysis of commodity booms and busts show that each cycle has lasted about 17 years for both the boom and the bust period.

The current cycle started around 2001 when gold, copper, and oil prices were at multi-decade lows. As a result, we’re only about one decade not the current boom. And if historical averages hold true, as it tends to do over the long run, there should be at least another seven years to go in the current boom.

In addition to the fundamental factors driving commodities prices, there is global debasement of currencies around the world. Inflation is running high and commodity prices are still very high. Commodity investments are some of the best investments to protect the value of savings since commodity investments act as a store of value.

How Can I Invest In Commodities?

There are a number of ways to invest in commodities.

The best way to invest in any specific commodity depends on the type of commodity.

For example, an investor wanting to put some money into gold or silver should probably start with buying bullion. The gold and silver bullion markets are broad, efficient, and highly liquid. In other words, when you want to sell your gold and silver, you can simply go to your local coin dealer or sell it on eBay and get a fair price that’s very close or at the market price.

An investor looking at oil, however, would need to take a different path. There are a number of different ways to get exposure to oil without having to buy a tank and put it in your yard or lease an oil tanker and fill it with oil. One of the best and most popular ways is to invest in the shares of oil companies.

The finally quick, low-cost, and effective way to get exposure to commodities is through Exchange Traded Funds (ETF). The explosion of ETFs available to investors over the last few years has opened up dozens of opportunities to own commodities. Most of the commodities either buy financial instruments directly tied to a commodity or a basket of commodities. The ETFs usually move up in the same percentage terms as the underlying commodity whether it’s oil, gold or corn. One of the largest commodity ETFs is the SPDR Gold Share (NYSE:GLD) which is worth 1/10 th of an ounce of gold.

How to Invest in Commodities Successfully

The key way to invest in commodities successfully is to focus on the cyclical nature of commodities prices.

Commodity prices move a lot like stocks. And the same rules of investing successfully in anything. Those strategies include buying out of favor commodities and focusing on the ones hitting new lows and beginning an uptrend.

Commodity investors tend to follow global economic trends and supply and demand factors which drive commodity prices over time.

For example, the combination of extended global economic malaise and technological innovation in oil production from previously unrecoverable sources will weigh on oil prices for years to come. There are many factors affecting oil, but the long term is rising supply and slow to no growth in demand will keep the downtrend in oil prices running forward.

Meanwhile, agriculture commodities are looking to be some of the best long-term bets. The combination of rising demand from rising disposable incomes around the world and limited supplies of new arable land to grow food are shaping up to push food prices higher over the long run. As a result, corn, wheat, barley and many other food commodities will rise in price steadily.

Commodity Investing: Stick the Fundamentals for Success

Finally remember one of the primary Contrarian Investing rules for any investment class including commodities:

No commodities boom ever lasts. It’s never different this time. And you will hear it is different in the middle of a boom. And it will feel like it’s different. Just like the tech bubble. It’s never different.

Buy commodities. Set trailing stops to limit your downside risk. And go for the ride up and avoid the eventual crash that will come.

Good investing,

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