Investing in Commodities For Dummies
Overview
Minimize risk and maximize profit as a commodities investor
Investing in Commodities For Dummies gives you an in-depth look at how commodities stack up against other assets and advice on how to avoid investing pitfalls. This book shows you how to diversify beyond stocks and bonds by moving money into a market that’s widely viewed as a safe haven during times of turmoil on Wall Street. You can learn to trade gold, silver, heating oil, US cotton, and many of the other things we need and use every day. Check out this easy-to-follow Dummies guide for the basics on breaking into the market, common myths, and a range of trading and investing strategies.
- Get started investing in commodities with step-by-step instructions
- Diversify your portfolio, measure risk, and apply market analysis techniques to commodity markets
- Find useful information and expert tips so you can make informed decisions
- Learn tips for identifying good trades, selling at the right time, and evaluating your hunches
Investing in Commodities For Dummies gives amateur investors—that’s you!—a comprehensive guide to trading, investing, and making money in the commodities arena.
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About The Author
AMINE BOUCHENTOUF is managing director at Commodities Investors, LLC, and has been trading the commodity markets for over 20 years.
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Commodities
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.
Because the commodities markets are so wide and deep, you have a number of investment vehicles to access these markets. A common misconception among investors is that you can only trade commodities by opening a futures account. While the futures markets certainly provide an avenue into the commodities markets, you have other tools at your disposal.
Commodities
Established in 1848, the Chicago Board of Trade (CBOT) used to be the oldest commodity exchange in the world. The CBOT was the go-to exchange for grains and other agricultural products, such as oats, ethanol, and rice. The exchange also offered several metals contracts targeted at individual investors, including the mini gold and mini silver contracts.
The whole reason Master Limited Partnerships (MLPs) exist is to distribute all available cash back to the MLP unit holders, which has to be done on a quarterly basis. These factors determine how much cash is distributed to each investor:
How many units the investors hold
The incentive distribution rights (IDRs) created for the GP
The difference between distributable and discretionary cash flow
The GP is responsible for distributing cash back to the LPs proportionally to their holdings.
Commodities
One of the biggest factors to watch out for as an investor is the ravaging effects of inflation. Inflation can devastate your investments, particularly paper assets such as stocks. The central bankers of the world — smart people all — spend their entire careers trying to tame inflation, but despite their efforts, inflation can easily get out of hand.
Commodities
Like the large integrated energy companies — ExxonMobil and BP — diversified mining companies are involved in all aspects of the metals production process. These companies, which often employ tens of thousands of people, have operations in all four corners of the globe. They're involved in excavating metals — both precious and base metals, ferrous and nonferrous — as well as transforming these metals into finished products and subsequently distributing the end products to consumers.
Commodities
If you spot a rally in gold, copper, or another individual metal and want to profit from this specific trend, the most direct exposure through the equity markets comes by investing in companies that specialize in specific metals. Following are some of these companies.
Newmont Mining: Gold
Newmont is headquartered in Colorado but operates gold mines all over the world.
Commodities
You can choose from a wide variety of crude oil products as investments. Crude oil by itself isn't very useful; it derives its value from its products. Only after it's processed and refined into consumable products such as gasoline, propane, and jet fuel does it become so valuable.
Crude oil was formed over millions of years from the remains of dead animals and other organisms whose bodies decayed in the earth.
Commodities
If you think delving into commodity derivatives isn't for you, you can access the commodity markets through funds. If you've invested before, you may be familiar with these two investment vehicles.
Commodity mutual funds
Commodity mutual funds are exactly like average, run-of-the-mill mutual funds, except that they focus specifically on investing in commodities.
Commodities
Profiting from the merger activity in the mining industry can be a good investment strategy. Since the year 2000, a number of large companies have entered into merger agreements (the marriage of the Australian BHP and the British Billiton, which resulted in BHP Billiton, is a good example), and this trend is likely to continue as mining companies seek to add new capacity by merging or acquiring smaller rivals.
The futures market is divided into two segments: one that's regulated and another one that's unregulated. Trading in the regulated portion of the futures market is done through designated commodity futures exchanges such as the New York Board of Trade (NYBOT) — now part of the Intercontinental Exchange (ICE) — and the Chicago Mercantile Exchange (CME).
Commodities
Oil companies get a bad rap. Whatever you may think of them, they make for a great investment. Integrated oil companies are sometimes known as "big oil," "the majors," or "integrated oil companies." These are the oil companies that are involved in all the phases of the oil-production process, from exploring for oil to refining it and then transporting it to consumers.
The New York Board of Trade (NYBOT) is one of the oldest exchanges in the United States and is the premier location for the trade of agricultural commodities. The NYBOT also offers futures contracts that track cotton, ethanol, and wood pulp (pulp is used to make paper), as well as products that track several financial futures, such as the euro (the currency), the New York Stock Exchange Composite Index, and the Reuters/Jefferies CRB Index.
One route you can take to get exposure to commodities is to buy stocks of commodity companies. These companies are generally involved in the production, transformation, or distribution of various commodities.
This route is perhaps the most indirect way of accessing the commodity markets because, in buying a company's stock, you're getting exposure not only to the performance of the underlying commodity that the company is involved in, but also other factors, such as the company's management skills, creditworthiness, and ability to generate cash flow and minimize expenses.
Commodities
The futures markets are the most direct way to get exposure to commodities. Futures contracts allow you to purchase an underlying commodity for an agreed-upon price in the future. Here are some ways you can play the futures markets.
Commodity index
Commodity indexes track a basket of commodity futures contracts.
Commodities
The Securities and Exchange Commission (SEC) requires publicly traded companies in the United States to file annual and quarterly reports. The quarterly report, known as Form 10Q, contains information about the company's financial operations during each of the first three fiscal quarters in a given year. (A company doesn't need to file a quarterly report at the end of the fiscal year, because that's when the annual report is released.
If you're investing in commodities, you want to make money. One way to do that is by using a commodity index. Consider the following few ways you can invest through a commodity index:
Own the futures contracts. One of the most direct ways of tracking the performance of an index is to own the contracts the index tracks.
Commodities
The idea that diversification is a good strategy in portfolio allocation is the cornerstone of Modern Portfolio Theory (MPT). MPT is the brainchild of Nobel Prize–winning economist Harry Markowitz. In a paper he wrote in 1952 for his doctoral thesis, Markowitz argued that investors must look at a portfolio's overall risk/reward ratio.
Commodities
Before you invest in a mutual fund, you need to gather as much information as possible about the fund itself, as well as about the mechanics of investing in the fund. You can get answers to these questions directly from the fund manager or the fund's prospectus.
Call the mutual fund company directly and ask for a prospectus.
Similar to the bond or stock markets, the commodities are populated by traders whose primary interest is making short-term profits by speculating whether the price of a security will go up or down.
Unlike commercial users who are using the markets for hedging purposes, speculators are simply interested in making profits; thus, they tend to move the markets in different ways.
One of the reasons MLPs are great for commodities investing is that, unlike regular corporations, they're taxed only once. Many publicly traded companies are subject to double taxation: They're taxed at the corporate level as well as at the shareholder (individual) level. Not so with MLPs.
Because of congressional legislation, any MLP that derives 90 percent or more of its income from activities related to the production, distribution, and transformation of commodities qualifies for this tax-exempt status.
As an investor interested in making money through index investing, you have five commodity indexes at your disposal. Although the composition and structure of every index is different, the aim is the same: to track a basket of commodities. Before you get into specific commodity indexes, watch out for these pitfalls when shopping for an index:
Components: Each index follows a specific methodology to determine which commodities are part of the index.
If you're interested in investing in companies that are involved in the production, transformation, and distribution of commodities, one of the best ways to do so is to invest in a master limited partnership (MLP). MLPs are a great investment because of their tax advantage and high cash payouts.
MLPs are public entities that trade on public exchanges.
You can get information on an offshore drilling company's fleet in its annual report. Companies usually lease these vessels to customers, which may include independent oil and gas companies, national oil companies, and the major integrated oil companies, for a premium. A company also includes this type of financial information regarding its fleet in the annual report.
Commodities
In practical terms, renewable energy refers to sources of energy that are essentially always present, always available, and always renewable. The sun and wind are traditional sources of renewable energy because the sun always shines and the wind always blows, day in and day out. Harnessing these renewable sources of energy is beneficial for a couple reasons.
Commodities
Just what, exactly, are commodities? Put simply, commodities are the raw materials humans use to create a livable world. Humans have been exploiting earth's natural resources since the beginning of time. They use agricultural products to feed themselves, metals to build weapons and tools, and energy to sustain themselves.
Is the world really running out of oil? The concept of peak oil has generated much attention in recent years. A plethora of books have been written about whether the world is running out of oil, and proponents (and opponents) of this theory have hit the airwaves en masse.
This topic is a serious one, but unfortunately, folks tend to get carried away and start spinning tales of global gloom and doom.
Essentially, two types of folks trade futures contracts. The first are commercial producers and consumers of commodities who use the futures markets to stabilize either their costs (in the case of consumers) or their revenues (in the case of producers). The second group consists of individual traders, investment banks, and other financial institutions who are interested in using the futures markets as a way of generating trading profits.
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