Investing in Commodities For Dummies
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The commodity waters can be perilous at times, and knowing how to navigate them is crucial. Keeping your eye on where the markets are heading — and where they've been — will help you develop a winning investment strategy. One way to identify where the markets are heading is to watch certain market indicators.

The ten key metrics highlighted here provide insight into what the markets are doing and help you design and calibrate an investment strategy based on the market fundamentals.

Consumer Price Index

The Consumer Price Index (CPI), compiled by the Bureau of Labor Statistics (BLS), is a statistically weighted average of a basket of goods and services purchased by consumers around the country. The CPI is the closest thing to a cost-of-living index and is sometimes used to gauge inflationary trends. If the CPI is rising, economists — especially the ones at the Federal Reserve — start worrying that inflation is creeping up.

A rising CPI may then result in an increase in the Federal Funds Rate. The CPI is sometimes broken down further into the Core CPI, which excludes items like food and energy. Comparing the CPI with the Core CPI can give you a good idea of how much consumers, who account for two-thirds of economic activity, are spending on commodities such as energy and agricultural products.

EIA inventory reports

Energy traders are glued to their Bloomberg terminals every Wednesday morning (at 10:30 a.m. EST, to be precise), waiting for the latest inventory reports. Those inventory reports come from the Energy Information Administration (EIA), which is the statistical branch of the Department of Energy (DOE), and they detail activity in the country's energy sector.

They include a summary of weekly supply estimates, crude oil supply, and disposition rates (consumer consumption), as well as production, refinery utilization, and any movement in stock changes. The EIA petroleum inventory reports may not get wide coverage in the press, but they have a direct impact on the price of crude oil and other energy products. Naturally, you'll want to monitor them regularly. You can find all the information about these reports by going to the EIA website.

Federal Funds Rate

Perhaps no other market indicator is as closely watched by investors as the Federal Funds Rate. When the financial press talks about interest rates going up or down, they're almost always referring to the Federal Funds Rate, which is established by the Federal Open Market Committee (FOMC). This is the short-term interest rate banks charge each other overnight for Federal Reserve balances. When the Fed wants to stimulate a sluggish economy, it tends to decrease this short-term rate.

On the other hand, if the Fed believes that the economy is overheating — and, therefore, subject to inflation — it increases this rate, which makes borrowing money more expensive.

Gross domestic product

Gross domestic product (GDP) is one of the most closely watched economic indicators. GDP is essentially a measure of all the goods and services produced in a country by private consumers, the government, the business sector, and trade (exports/imports). GDP, especially per-capita GDP (which essentially measures purchasing power on an individual level), is a good indication of the likely demand for and activity in commodities.

The higher the GDP growth, the more likely a country is to spend more money on purchasing crude oil, natural gas, and other natural resources. Of course, GDP gives you a big picture of the economic landscape and may not necessarily identify specific trends. That said, solid and growing GDP is a good measure of economic health and is a bullish indicator for commodities.

London gold fix

Gold is a special commodity because it's one of the only commodities that has a monetary role. For decades, many currencies — including the U.S. dollar and the British pound — were fixed to gold. Even though President Richard Nixon took the United States off the gold standard in 1971, thereby heralding a floating exchange rate regime, gold is still used as a global monetary benchmark. The Federal Reserve and other central banks hold gold bullion in vaults for monetary purposes, and economists sometimes use gold as a measure of inflation.

Monitoring gold, both as a possible measure of inflation and for its monetary stability, is a good idea. Spot gold prices are fixed in London daily — in what is known as London gold fixing — by five leading members of the financial community. Precious metals dealers closely monitor the London gold fix and use it as a global benchmark for gold spot prices. You can also get an idea of where gold prices are heading by consulting the futures markets, specifically the COMEX gold futures prices provided by the Chicago Mercantile Exchange (CME/COMEX).

Nonfarm payrolls

As with the Consumer Price Index, nonfarm payrolls are compiled by the Bureau of Labor Statistics. Statistically, nonfarm payrolls include the number of individuals with paid salaries employed by businesses around the country. It does not include government employees, household employees (homemakers), individuals who work in the nonprofit sector, and workers involved in agriculture.

Nonfarm payrolls include information on about 80 percent of the nation's total workforce, and this number is often used to determine unemployment levels. The nonfarm payroll report is released monthly, on the first Friday of the month, and does not include total employment; instead, it shows a change between the current employment levels and previous employment levels, as measured by the new number of jobs added. The higher the number, the stronger the economy and the more people hired by businesses — which all means that consumers have more money to spend.

Although the link is indirect, higher nonfarm payroll numbers can be interpreted as a bullish sign for the commodities markets.

Purchasing Managers Index

The Purchasing Managers Index (PMI), released by the Institute of Supply Management (ISM), is a composite index and a good indicator of total manufacturing activity, which, in turn, is an important barometer of overall economic activity. The manufacturing sector is a large consumer of commodities, such as crude oil and natural gas, and a strong PMI signals that manufacturers are doing well and are likely to spend additional dollars on commodities. The PMI is released at 10 a.m. EST on the first business day of every month.

Reuters/Jefferies CRB Index

The Reuters/Jefferies CRB Index is the oldest commodity index and is one of the most widely followed commodity benchmarks in the market. Although commodity indexes have their shortcomings — for example, they track only commodities on futures contracts, thereby ignoring important commodities such as steel — they're the best measure of where the commodities markets as a whole are heading. The Reuters/Jefferies CRB Index tracks 19 commodities, everything from crude oil and silver to corn and nickel.

U.S. dollar

Keeping your eye on what the U.S. dollar is doing is critical for a variety of reasons. U.S. dollars are the world's de facto currency, so most of the world's crucial commodities, from crude oil and gold to copper and coffee, are priced in them. Any shift in the dollar has an indirect impact on these important markets. For example, the integrated energy companies (the majors) have operations around the globe and often deal with the local currency in the area they're operating. Any shift in the local currency/U.S. dollar exchange rate has a direct impact on how the companies account for profits and expenses, as well as other metrics.

WTI crude oil

West Texas Intermediate (WTI) crude oil is one of the most widely followed benchmarks in the energy complex. WTI is a high-grade, low-sulfur, premium crude produced in West Texas. This light, sweet crude is traded on the NYMEX section of the Chicago Mercantile Exchange (CME/NYMEX) through a futures contract, which is widely quoted in the financial press and in analyst reports as a benchmark for global oil prices. More important, industry players use it as a benchmark for global oil prices.

Of course, because the price of the CME/NYMEX WTI refers only to light, sweet crudes, the price of heavy, sour crudes is going to be different. Currently, most heavy, sour crudes are priced relative to their lighter and sweeter counterparts.

About This Article

This article is from the book:

About the book author:

Amine Bouchentouf is a registered investment advisor, a member of the National Association of Securities Dealers, and a partner at Commodities Investors, LLC. A world-renowned market commentator, he has appeared on media in the US, the UK, France, the United Arab Emirates, and Brazil.

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