What You Should Know About Investing In Commodities
Recent strong performance has attracted a lot of neophytes. They may have much to learn.
Recent strong performance has attracted a lot of neophytes. They may have much to learn.
After years in the investing wilderness, commodities are hot again. And it looks as if the rally may continue for at least the foreseeable future, some analysts say.
The speed of the rally has been striking. The Refinitiv/CoreCommodity CRB Index, which tracks a basket of commodities selected to represent prices of futures contracts across the whole sector, doubled from April 2020 through mid-February.
That performance follows a yearslong period when the index trended lower. And the surge is now attracting investors of all types—from veterans to neophytes.
The latter would do well to understand some of the basics in how commodity investing works. Commodities typically get grouped into three broad buckets: energy, foodstuffs and materials. Each has endemic risks, including weather, local and geopolitics.
Each also offers the possibility of direct investment, in the commodities themselves, or indirect investment, through vehicles such as mutual funds and exchange-traded funds. For the relatively inexperienced, direct investing in commodities can be particularly challenging, in part because of additional costs and risks generally not found in other types of investing. We’ll get to those details in a moment.
What follows is a look at some of the basics of commodity investing.
The price of each commodity gets determined by the supply and demand dynamics for that item. For instance, last year bad weather in Brazil hurt the coffee crop and pushed up the cost of beans. Likewise, an attack on an oil-refining plant in the Middle East will tend to disrupt supplies and spark an energy-market rally.
Commodity markets are global. What happens in one country can have an impact on commodity prices world-wide. Therefore, all commodity investors should keep an eye on what’s happening not just in the U.S. but around the world.
While even just the risk of war can send prices higher for commodities, particularly those that originate in the countries directly involved, actual invasion tends to send those prices even higher. That is exactly what happened with the conflict between Ukraine and Russia as both countries are leading exporters of foodstuffs. Although the invasion began on Feb. 24, prices were rising long before. A bushel of wheat is fetching $13.48, up 77% from $7.61 at the beginning of February on fears that global supplies would be disrupted. Likewise, corn prices have rallied 21% over the same period. Such surges added to those already happening in the commodity markets. Even before the war, unfavourable weather- and pandemic-related disruptions across the world were reducing supplies and sending prices higher when production couldn’t keep up with demand.
Sometimes a price change in one commodity causes the cost of another one to move as well. One typical example is in livestock farming. Farmers sometimes switch from feeding hogs or cattle with costly grain to less-pricey alternatives. They might decide to buy corn from arable farmers instead of wheat or vice versa depending on the relative prices. In turn, those prices change to reflect the new demand for each product. This phenomenon shouldn’t be too surprising. Imagine if the cost of aged blue Stilton increases at the supermarket; at least some people will likely switch to a less-expensive cheese.
Unlike commodity traders and other professionals whose direct positions in oil or grain might change from second to second, average investors in commodities will have longer time frames in mind for their commodity-related holdings. But a simple buy-and-hold strategy here won’t help you accumulate wealth as it would in the stock market.
Commodity prices can frequently trend lower for decades. New technologies, such as better farming techniques or methods of mineral extraction, have allowed supplies to increase over time, depressing prices.
For instance, oil hit a record high of around $147 a barrel in 2008 versus the current price of $115.68. Likewise, Arabica coffee prices peaked at $3.35 a pound in 1977 versus $2.24 now. When these prices get adjusted for inflation, the declines look starker.
Thus, even for individual investors in commodity-related investments, timing in these markets can be critical. Whether you think of your investment as short term or long term, investors need to pay attention to buy at the right moment and sell at an auspicious one. Lean-hog prices tripled from 37 cents a pound in April 2020 to $1.20 in June 2021 before collapsing to 72 cents in October. Anyone not ready for such swings will be in for a shock and an emotional roller coaster.
Adding commodities to a larger balanced portfolio can also help reduce risks as commodity prices tend to have low correlation to other assets such as stocks and bonds. That means when the S&P 500 falls, commodity prices may go up, or down, or not move at all.
One more advantage to investing directly in commodities rather than commodity companies is that a layer of risk is removed. When investing in stock there is always the possibility that management may make mistakes even when the underlying sector economics are favorable.
Commodity investors typically don’t operate in the cash market, meaning they don’t purchase physical materials such as metals, oil, or foodstuffs. Instead, traders mostly buy or sell futures contracts in the hope of benefiting from the increase or decrease in prices. These contracts are legally binding agreements to buy or sell a specific volume of a commodity on a specific date in the future.
Ultimately, the prices in the futures market and those in the cash market will tend to converge. That’s why commodity producers and consumers use futures to hedge the risks of market price movements.
Most stocks pay dividends to investors, meaning you can make money even if the share prices don’t move. Pretty much the opposite is true for commodity investors. It costs money to own commodities. For example, a buyer of 100 ounces of gold bullion will need to cover the costs of storage and insurance for the metal. While such expenses can be low for precious metals, they can stack up faster for crude oil and grains such as wheat and corn as more extensive facilities are needed to hold the stuff.
For fund investors, there are many choices. More than 150 mutual funds and ETFs cover the sector. Unfortunately, that means much due diligence is required. In short, it’s essential to understand what the fund owns and what its strategy is.
Just as with stocks, there are both passive funds (those that track a benchmark index) and active ones (those that follow a discretionary investing strategy).
In the passive category, some track the price of single commodities, such as SPDR Gold Shares ETF (GLD) and Invesco DB Gold Fund (DGL), which track slightly different benchmarks. Likewise, there is an ETF for wheat, Teucrium Wheat (WEAT). There are also passive funds that are designed to track groups of commodities, such as Invesco DB Base Metals (DBB), or the whole sector, such as iShares S&P GSCI Commodity-Indexed Trust (GSG).
Actively managed funds, such as the active ETF First Trust Global Tactical Commodity Strategy Fund (FTGC), make decisions on what commodities to buy or sell.
There are a couple of wrinkles to watch out for with all types of funds. First, average investors should avoid any fund that uses leverage to enhance performance. Such funds often promise to deliver two or three times the performance of a given commodity. While that means such funds can deliver multiplied profits, they also magnify losses.
Other funds claim that they’ll mimic an inverse performance so that if a commodity’s price falls, the fund will increase in value by a similar amount. This isn’t the same as a hedge against losses unless the trade is made specifically to diversify risk within a larger portfolio. Another problem with these funds is that there can be significant tracking errors. These funds are best left to sophisticated investors.
It’s also worth being cautious about exchange-traded notes, or ETNs. This type of investment can expose investors to the risk that the fund company goes bust. ETFs and mutual funds protect investors against such events.
As with all investing, investors should find funds with low expense ratios. Annual fund expenses mainly range from 0.5% to 1%. Leveraged funds tend to have expenses of 1% and more. These compare with costs of 0.09% for SPDR S&P 500 ETF, which tracks the S&P 500.
Investing guru Jim Rogers famously made a boatload of money during the 1970s investing in the commodity markets while material prices and food costs jumped. And there will likely be other people who do similarly again.
However, even the most sophisticated investors sometimes come unstuck, such as the Hunt brothers. In 1980 they accumulated major positions in the silver futures market using borrowed money. But a change in exchange rules led to a price drop, and quickly the brothers couldn’t cover their obligations. In other words, be careful in the commodity markets.
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Andy Warhol’s portrait of the late Queen Elizabeth II sold for C$1.14 million (US$855,000) at an auction last week, setting a record price for an editioned print by the Pop artist, the Canadian auction house Heffel said.
Warhol created the screenprint in 1985 based on a photograph taken by Peter Grugeon at Windsor Castle in 1975, which was released in 1977 on the occasion of the Queen’s Silver Jubilee, according to Heffel.
Queen Elizabeth II died in September at the age of 96 after a seven-decade reign, making her one of the longest-reigning monarchs in history.
The portrait features the then-reigning Queen wearing the diamond-and-pearl Grand Duchess Vladimir Tiara and a matching necklace, and a blue sash pinned with a medallion with a miniature portrait of her father, George VI, on regal blue background. The outline of the portrait was accentuated by diamond dust, which glimmered in the light.
This print is one of only two editions signed as “HC” for Hors d’Commerce (not for sale) aside from the 30 numbered editions with this colour scheme and diamond dust, according to Heffel.
The consignor acquired the print circa 1996 from Bob Rennie, a prominent Vancouver businessman and collector, according to Heffel, which declined to disclose the identities of the consignor and the buyer.
Offered as a highlight at Heffel’s 85-lot auction of Post-War and contemporary art on Nov. 24 in Toronto, the print realised a price more than double its presale estimate, and was the highest achieved by an editioned print by Warhol, the auction house said.
The previous auction record for an editioned Warhol print was for a piece from the same edition, also in the regal blue colour, sold in September at Sotheby’s for £554,400 (US$662,000), according to Heffel.
The most expensive Warhol work is his portrait of Marilyn Monroe, Shot Sage Blue Marilyn, which was acquired by gallerist Larry Gagosian at a Christie’s auction in May for US$195 million, marking a record price for a work by an American artist at auction.
The iconic bootmaker is now solely in local hands.