What is commodity investing?
Investment in commodities
Investing in commodities can be done in a variety of ways. One option is to buy various amounts of physical raw materials like precious metal bullion. Futures contracts or exchange-traded products (ETPs) that directly track a single commodities index are also available to investors. These are high-risk, high-complex investments that are usually only recommended for experienced investors.
Mutual funds that invest in commodity-related businesses are another option to obtain exposure to commodities. An oil and gas fund, for example, might invest in equities from companies involved in energy exploration, refining, storage, and delivery.
Stocks of commodities vs. commodities
Is it true that commodity stocks and commodities always produce the same results? Certainly not. Maintaining an allocation to each category may assist add to a portfolio's overall long-term success when one investment exceeds the other.
Advantages of commodity investing
Commodities and commodity stocks have a different return profile than other equities and bonds over time. You can better handle market volatility by having a portfolio containing assets that don't move in lockstep. Diversification, on the other hand, does not guarantee a profit or protect against loss.
Supply and demand, exchange rates, inflation, and the overall health of the economy can all affect individual commodity prices. Increased demand due to huge global infrastructure projects has had a significant impact on commodity prices in recent years. Commodity price increases have had a beneficial impact on the stocks of companies in connected industries in general.
Potential inflation protection
Inflation, which can depreciate the value of stocks and bonds, can lead to rising commodity prices. While commodities have performed well during periods of rising inflation, investors should keep in mind that commodities are far more volatile than other investments.
Risks of commodity investing
Commodity prices can be extremely volatile, and world events, import bans, global competition, government laws, and economic conditions can all have an impact on commodity prices. There's a danger that your investment will depreciate in value.
Volatility can be higher than average in mutual funds or exchange-traded products (ETPs) that track a specific sector or commodity. Commodity funds or exchange-traded products (ETPs) that use futures, options, or other derivative instruments can also raise volatility.
Exposure to foreign and emerging markets
These funds, in addition to the risks associated with commodities investing, also carry the risks associated with investing in foreign and emerging markets, such as volatility induced by political, economic, and currency instability.
Concentration of assets
While commodity funds can help with diversification, they are deemed non-diversified since they invest a large amount of their assets in a small number of individual securities that are typically focused in one or two industries. As a result, changes in the market value of a single investment may generate bigger share price swings than in a more diversified fund.
Futures contracts may be utilized by commodities-focused stock funds to monitor an underlying commodity or commodity index. Trading in these types of assets is risky and volatile, with the potential for a fund's performance to deviate dramatically from that of the underlying commodity. Depending on market conditions and the fund's investing strategy, this difference can be beneficial or negative.
Why Should Investors Consider Commodity ETFs?
Commodities have outperformed in the wake of the recent turmoil, and the asset class might be an important part of a well-balanced exchange traded fund investment portfolio, both in times of turmoil and as a strategic, long-term allocation.
Robert Minter, Director of ETF Investment Strategy, abrdn; and Steven Dunn, Head of Exchange Traded Funds, abrdn, explained in a recent webcast, How Global Tension Has Fueled Inflation and Commodities, that as geopolitical tensions have increased, so has the focus on commodities. While the humanitarian impact is unquestionably the most important, there are also major economic consequences due to already-high oil prices, inflation, and supply chain disruptions.
While the Russia-Ukraine conflict is one factor contributing to the current increase in commodity prices, there are undoubtedly other forces at play. A global theme has been falling supply and rebounding post-coronavirus demand.
The abrdn analysts, for example, pointed to dwindling supply of base metals like copper. While prices have been rising, capital expenditure on new mining projects has been slow to respond, especially since many companies were burnt the last time they tried to expand operations quickly with significant spending plans.
This is also mirrored in the energy sector where rig counts remain low and oil producers are loath to make a knee-jerk reaction to surging crude prices. At the most recent count, about 533 oil rigs were pumping out crude, compared to the highs of above 1,400 back in 2014. According to the latest Dallas Federal Reserve energy survey, a number of variables are contributing to high energy costs and producers' delayed response to pumping out additional oil.
The energy survey specifically mentioned a labour shortage, as well as rising delivery, pipe, fracking sand, and other costs. Meanwhile, the Biden administration has stymied the construction of fossil fuel infrastructure, including the Keystone XL project. Energy businesses are concerned about increased regulation and a greater focus on climate change or ESG issues.
Weather has hampered growth and supply in the soft commodities and agriculture sectors. Various weather-related crop damages have been caused by the so-called La Nina weather phenomenon.
Finally, geopolitical risk, or the aftermath from the Russia-Ukraine conflict, has been a recent negative contributor to global commodities supply. For example, in 2019, the European Union imports 26.9% of its crude oil, 41.1 percent of its natural gas, and 46.7 percent of its solid fuels from Russia. With a total of $330 billion in commodities exports in 2020, Russia is also a major producer of other commodities such as gold, base metals, and more.
Long-term trends may still exist, according to the abrdn experts; therefore investors should keep an eye on commodities as an alternative asset to diversify a standard stock and bond portfolio. Inflation and deflation cycles have averaged 18 years in the past. Commodities have provided better diversification benefits than typical stock and bond holdings, with low correlations. The Bloomberg Commodity Index, for example, has had a 20-year average volatility of 16.16 percent, vs. 19.57 percent for the S&P 500 Index.
Several ETF options are now available to investors looking to diversify their portfolios with broader commodity exposure. abrdn (previously Aberdeen Standard Investments) offers a line of ETFs that outperform the widely followed Bloomberg Commodity Indices, all without the hassle of tax season K-1 forms. The abrdn Standard Bloomberg All Commodity Strategy K-1 Free ETF (NYSEArca: BCI) and the abrdn Standard Bloomberg All Commodity Longer Dated Strategy K-1 Free ETF (NYSEArca: BCI) are two actively managed funds (NYSEArca: BCD).
The Bloomberg Commodities Index (BCI) aims to produce long-term capital appreciation that outperforms the Bloomberg Commodities Index. It may not invest in all of the index's components, but it will invest in short-term investment-grade fixed income securities, money market instruments, particular bank instruments, and cash or other cash alternatives that are similar to those in the index.
The Bloomberg Commodities Index, which underpins the index, follows the price of rolling holdings in a basket of commodities futures with maturities ranging from one to three months. BCD aims to outperform the Bloomberg All Commodity Index 3 Month Forward Index, which tracks changes in the price of rolling contracts in a basket of commodity futures with a maturity of four to six months.
Several physically-backed metals-related ETFs, such as the abrdn Standard Gold ETF Trust (SGOL), the abrdn Standard Physical Silver Shares ETF (SIVR), the abrdn Standard Physical Platinum Shares ETF (NYSEArca: PPLT), and the abrdn Standard Physical Palladium Shares ETF (NYSEArca: PPLT), can be used to diversify a traditional portfolio mix (NYSEArca: PALL). The abrdn Standard Physical Precious Metals Basket Shares (NYSEArca: GLTR) also serves as a metals catch-all, including a combination of gold, silver, platinum, and palladium.