Investing in Commodities via the Futures Markets - dummies

Investing in Commodities via the Futures Markets

The futures markets are the most direct way to get exposure to commodities. Futures contracts enable 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 indexes

Commodity indexes track baskets of commodity futures contracts. Each index uses a different methodology, and the performance of each is different from its peers. Commodity indexes are known as passive, long-only investments because they aren’t actively managed, and they can only buy the underlying commodity; they can’t short it.

Here are the five major commodity indexes you can choose from:

  • Goldman Sachs Commodity Index (GSCI)

  • Reuters/Jefferies Commodity Research Bureau Index (R/J-CRBI)

  • Dow Jones-AIG Commodity Index (DJ-AIGCI)

  • Rogers International Commodity Index (RICI)

  • Deutsche Bank Liquid Commodity Index (DBLCI)

Futures commission merchants

To buy futures contracts, options, and other derivatives, you probably want to open an account with a futures commission merchant (FCM). Don’t be intimidated by the name — an FCM is very much like your regular stockbroker, except he doesn’t buy and sell stocks. Opening an account with an FCM gives you the most direct access to the commodity futures markets.

Commodity trading advisors

If you’re interested in investing in commodities through the futures markets or on a commodity exchange, getting advice from a trained professional is always a good idea. One option is to hire the services of a commodity trading advisor (CTA). Like an FCM, a CTA can help you open a futures account and trade futures contracts. But she also can help you develop an investment strategy based on your personal financial profile.

Commodity pools

Another way you can get access to the commodities futures markets is by joining a commodity pool. As its name suggests, it is a pool of funds that trades in the commodities futures markets. The commodity pool is managed and operated by a designated commodity pool operator (CPO) who is licensed with the National Futures Association (NFA) and registered with the Commodity Futures Trading Commission (CFTC). All investors share in the profits (and losses) of the commodity pool based on how much capital they’ve contributed to the pool.

Investing in a commodity pool has two main advantages over opening an individual trading account with a CTA. First, because you’re joining a pool with a number of different investors, your purchasing power increases significantly. You get a lot more leverage and diversification if you’re trading a $1 million account as opposed to a $10,000 account.

The second benefit, which may not seem obvious at first, is that commodity pools tend to be structured as limited partnerships. This means that, as an investor with a stake in the pool, the most you can lose is the principal you invested in the first place. Losing your entire principal may seem like a bad deal, but for the futures markets this is pretty good!