This article aims to break down the essence of commodities to help you better understand what they’re all about, how their prices are affected, the difference between commodities and stocks, if you actually get to own the commodities you’re buying.
What are commodities?
You buy your clothes depending on where they’ve come from, you choose your aftershave or perfume depending on who made it and you choose your food depending on the supplier. It’s the same with stocks, you choose who you invest in. However, the majority of people don’t care where gold, silver, copper come from, nor where corn or flour comes from. These things are known as commodities and are seen as areas where people can invest in the product, not the company.
Essentially, commodities are raw materials that are either found or produced from the Earth. There are two types of commodities, hard and soft.
- Hard commodities are those that require the use of drilling or are mined from the earth such as gold and most precious metals.
- Soft commodities are those that are grown or ranched such as flour or beef.
How are prices affected? 📈
Supply and demand are the driving factors on the commodity market as it is with most things. However, when it comes to commodities it can be a little ticky to predict as things such as weather can have a massive impact on commodity prices. For example, should there be a hot winter, prices in gases will decrease as there isn’t as much of a demand. Meanwhile, if there is a drought it can lead to crop prices rising due to the supply being restricted.
This means that there is volatility in commodities as there is in the traditional stock markets. Although, just like in traditional stock markets, there are safe haven options. One of these is gold as when the economy crashes it usually means gold increases in price as countries look to their reserves.
Most people know someone who has invested in gold and they often follow it up with ‘it’s one of the safest investments you’ll ever make’ in their know it all voice. Well, they’re right and wrong. We’ll be touching on this more in our next article.
How do I invest in commodities? 🤑
When it comes to investing in commodities, there are three main ways to do it. Invest in futures, invest in ETFs or invest in the physical commodity.
Futures offer a different kind of way to invest in commodities. Also known as futures contracts, the way they work is as a price of a commodity increases the buyer will benefit as it is set at a pre-agreed price. Although, when the price drops then the seller of the futures contract will make a profit from the loss to the buyer. This is why you will see futures contracts used in hedging, as a way to reduce your risk of exposure but are mainly used by experienced traders who can afford to have the risk.
Another reason why futures contracts are for experienced traders is because you have to put up a lot of capital to start investing. For example, if you wanted to have a single gold futures contract you would need to invest around £137,000 at the time of writing this article. That’s for 100 ounces of gold.
On the other hand, you have exchange-traded funds (ETFs) which look to bridge the middle ground between large investments and individual investors who don’t have that kind of capital. In some cases ETFs will have their own physical commodities and offer shares of this commodity to investors that will be of a certain amount. When it comes to gold for example you have the SPDR Gold which is an ETF of gold bullion and tracks the price of one-tenth of an ounce of gold. Whilst others use futures contracts to replicate exposure to the asset price to take advantage of the exposure that may be available.
Finally you have the opportunity to invest in the actual commodity and physically own and store it yourself. This varies from commodity to commodity, for example gold won’t be hard to store but oil and crops would. You can of course invest in renting suitable containers for these commodities but that adds to the cost of your investment.
What do you actually own once you invest in a commodity with Revolut? 🤔
When you invest with Revolut currently there is one option, gold. We’re aiming to add further precious metals to our offering later down the line. Every time you exchange your e-money into gold, Revolut buys physical metal in the market and stores it with our trusted gold services partner in a London vault. You own exposure to those metal bars, which means you can't send this gold externally or have it delivered to you. Otherwise it is as good as a gold bar stored with us!
For more information around this, we have a very useful FAQ page offering more information around what you’re getting when you invest in a commodity with Revolut.
Next week we’ll be looking at breaking down the types of commodities even more and why there has been an increase recently in investments around commodities.
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