ZuluTrade Blog

How to Invest in Commodities (Without Having to Be an Expert)

Knowledge Crunch | Thursday, September 16, 2021 11:28 AM GMT

Looking for how to invest in commodities

The idea of owning barrels of oil and bushels of soybeans might seem an interesting prospect, and you're in the right place to learn exactly how to do it. 

The commodities markets have unique characteristics compared to buying stock or forex but getting involved isn't so different. 

To help you learn how to buy commodities, we're going to explore: 

  • Precisely what a commodity is
  • What it means to trade commodities
  • How commodity trading has developed over the centuries
  • Some of the most interesting commodities to trade

 

Finishing up with an easy-to-follow guide to start trading commodities. 

That's a lot to check out, so let's get stuck in.

 

Table of Contents

 

What is a Commodity?

What is Commodity Trading?

The History of Commodity Trading

Types of Commodities You Can Trade

 Step-by-Step Process for Trading Commodities

 

What is a Commodity?

A commodity is a financial instrument that's traded on markets and exchanges based on raw materials and farm produce before they get processed. 

Commodities tend to be things that are mined or extracted from the Earth or food and livestock that gets farmed. 

Some examples of extracted commodities include:

  • Crude oil
  • Gold
  • Silver
  • Palladium
  • Copper

 

Among other fossil fuels and precious metals. 

This type of physical commodity is usually referred to as a hard commodity, whilst agricultural products are called soft commodities

Some examples of soft commodities would be:

  • Wheat
  • Corn
  • Soybeans
  • Pork bellies

 

According to the US Commodity and Futures Trading Commission, cryptocurrencies like Bitcoin and Ethereum are also classed as a commodity, but we look at these in a separate article. 



Prices can be determined by politics in the case of oil and gas, or by the weather for any agricultural projects, for example, thus making commodities more volatile and high-risk. 

Usually, a commodity trader will buy and sell ownership of these materials without ever owning them, let's see how that can happen.

 

What is Commodity Trading?

Commodity trading is when an individual or business invests in a commodity like metals, fuels, or grains, and later sells them with the aim of making a profit. 

In a similar way to foreign currency or stocks, commodity prices are volatile and traders are able to make a profit - or a loss - by predicting price fluctuations of the materials. 

What causes those market prices to change? 

Some commodity price movements can be greatly affected by the forex market, e.g. the US dollar and gold have an inverse relationship - when USD goes down, the price of gold increases because it's less susceptible to inflation. 

 

Image Source: Macrotrends



In this chart, the orange line is the LBMA fixed price of gold and the blue line is a trade-weighted US dollar index; you can see there is a clear correlation between the price of gold and the value of the dollar

Meanwhile, soft commodities can be affected by the weather, such as a drought in wheat-growing areas in the USA over summer 2021 leading to a decline in wheat futures (WHEATF) in July that year, as you can see in the graph below. 

 

Image Source: TradingView

 

Most commodities are traded as futures contracts - where a trader agrees to buy or sell a specific commodity on an agreed date for a set price without actually owning the underlying commodity. 

In theory, these contracts should end with the commodity, e.g. 5,000 bushels of soybeans, being physically delivered. 

However, in reality, the majority of futures contracts are dissolved before they ever reach completion.

Futures trades are generally based on leverage; if your position starts to fall, you could be subject to a margin call where you have to inject more funds into your brokerage account or have the position closed. 

There are two types of market actors who trade commodities: 

  1. Manufacturers, such as airlines buying large amounts of fuel or phone makers who need a lot of rare-earth metals, want to lock in the price of their supply by hedging their real market position with an opposite one in the derivatives market. 
  2. Speculators, like individual traders or investment institutions who will trade futures in an attempt to profit from price changes and volatility.

That need of manufacturers to lock in the price of raw materials is the reason why commodities trading began. 

Here's more detail on the foundations of commodities trading.

 

The History of Commodity Trading

Investing in commodities has been around for a long time, with some historians claiming that the Sumerians were the first to trade commodities over 6,000 years ago. 

However, the first commodities market as we would recognize it today was in the USA in 1848; the Chicago Mercantile Exchange, followed by the New York Mercantile Exchange in 1888. 

These exchanges, and others like them in the USA, were mainly for trading agricultural products, including things like: 

  • Grains
  • Cotton
  • Milk
  • Eggs

 

Over the years, commodities markets have developed and consolidated in the States, and the main exchanges today are: 

  • The Chicago Board of Trade (CBOT), which trades gold, ethanol, corn, soybeans, and more.
  • The Chicago Mercantile Exchange (CME), which trades lean hogs, pork bellies, live cattle, and more.
  • The Intercontinental Exchange (ICE), based in Atlanta, Georgia, which trades in energy markets, crude oil, natural gas, and more.


Photo by Brad Huchteman on Unsplash

 

Meanwhile, in the UK, corn exchanges were a common sight in most large towns and cities from the mid-1800s.

These were large trading halls where farmers and merchants would go to fix prices for barley, wheat, and corn. 

These hyperlocal markets no longer exist; the advent of mass transportation meant it was easier for resources to be traded over much greater areas. 

Now, the main commodity exchange in the UK is the London Metal Exchange (LME), which traces its roots back to 1571

It was officially founded in 1877 when the industrial revolution called for stability in metal prices as ores were shipped from around the globe. 

 

The LME still specializes in

  • Gold
  • Silver
  • Copper
  • Zinc
  • Tin 
  • Lead

 

Millions of commodities trades are made each day, with some exchanges still having a physical trading floor, like the LME, whilst the CME decided to not reopen its grain trading pits after closing them for the COVID-19 pandemic. 

Now you know the details of what commodities trading is and where it came from, let's look at the types of resources you can trade online.

 

Types of Commodities You Can Trade Online

The World Bank tracks prices for 69 global commodities, but you've probably not heard of a lot of them and likely understand the markets for them even less.

We've noted a few commodities here that you probably know a little about and most of them are accessible to trade online, like gold, wheat, and oil.

However, actual commodities don't have much liquidity since there is less demand for bushels of corn or sacks of rice, for example. 

This means that you and most other market actors use different financial instruments like futures contracts and options trading, which are both a type of derivative. 

Since futures contracts are easier to understand and value than options, we're going to be talking about trading commodities with futures contracts here.  

Looking for commodities to trade? Here are a few of the most popular ones available in financial markets.

 

Commodity #1: Gold

This particular commodity is probably one of the most well-known ones and one you're likely to already own. 

The price of gold is generally a good indicator of the global economy - investors retreat to gold in times of economic uncertainty or when the stock market isn't performing well though its position was taken by crypto and other instruments.

In the chart below, you can see how the price of gold jumped between March and April 2020 as the gravity of the COVID-19 pandemic struck home. 

Image Source: MacroTrends

 

In March 2020, gold was priced at $1.697 per ounce and by April, one ounce was trading at $1,828.

Here's what you need to do to invest in this commodity that's been traded for millennia.

 

How to invest in gold

You and just about anyone else can own gold -  by going to a shop that sells jewelry or ordering it online but still there is risk in doing this.

Although most people are familiar with gold as a necklace, ring, or watch, you can buy bullion or gold bars

The most common way to buy gold bullion is a 1 Troy oz, which weighs 31.1 grams or 1.1 "normal" ounces. 

You can also buy gold as a futures contract, traded as XAU/USD because you're buying a contract to purchase gold with dollars in the future. 

The third way you can invest in gold is through commodity ETFs (exchange-traded funds) that include gold in their mix. 

For example, the Graniteshares Gold Trust (BAR) is invested in gold and "[seeks] the performance of the price of gold, less trust expenses" through holding gold in a London vault on investors' behalf. 

That's everything you need to know about investing in gold, let's look at what is sometimes called "black gold".

 

Commodity #2: Oil

The price of oil is a subject of much discussion in the media and is another indicator of how an economy is doing. 

This is because oil and its derivative products are vital to the functioning of nearly every economy in the world, such as

  • Gasoline
  • Plastics
  • Lubricants
  • Medications
  • Insulation and flooring

Photo by Mehluli Hikwa on Unsplash

 

There is a limited amount of oil in the world and only a few countries have their own  supply which can grant them power in international politics. 

OPEC, the organization of petroleum-producing countries, is able to control the price of oil to an extent by all member countries agreeing to increase or decrease supply as they see fit. 

You probably have heard some of the different types of oil; the two most common ones that are traded are: 

  1. Brent Crude, from the North Sea off the coast of the UK and Norway
  2. West Texas Intermediate (WTI), drilled in the USA

Because these oils are easier and less expensive to refine, they are the ones traders are most interested in. 

Image Source: Macrotrends

 

Above is the price of Brent Crude (BZ:NMZ), where you can see the volatility of the market over the last five years.  

If you're interested in getting to grips with oil prices and trading oil as a commodity, here's how you can do it.

 

How to invest in oil

To invest in energy commodities like oil, you have a few different choices. 

Unlike gold, you can't generally buy a barrel of oil and you probably wouldn't want to. 

Instead, you have three main options:

  1. Trade oil and oil futures contracts
  2. Buy stock in an oil company
  3. Invest in a mutual fund or ETF that holds oil

 

To trade in oil, you can look for the "spot" price, which is the price to buy a barrel of oil today, e.g. USOILSPOT, or an oil futures contract such as with UKOIL. 

The stock price of an oil company tends to be broadly linked to the price of oil but can be a much longer-term investment, depending on the trading strategies you use. 

For example, you can buy stock in ExxonMobil (XOM), which is one of the biggest, publicly traded oil and gas companies in the world. 

Image Source: Yahoo Finance

ExxonMobil doesn't drill for WTI but it does extract Brent crude among many other oils from around the world, so the company's value is linked to the oil markets

To invest in oil through an EFT, there are large funds such as Vanguard Energy ETF (VDE) and VanEck Vectors Oil Services ETF (OIH), plus the mutual fund Fidelity Select Energy (FSENX) invests in at least 80% in energy stocks including oil companies. 

Let's see the next type of commodity you can trade.

 

Commodity #3: Copper

Copper is a sought-after metal used in industrial processes and in construction - the wires in your home are very likely made of copper!

Because of its many uses across construction, manufacturing, and electronics, copper is in high demand. 

Photo by Steve Johnson on Unsplash

 

However, copper isn't rare - there is an estimated 5 billion tonnes of copper available to be mined and annually we use around 28 million tonnes. 

Copper is  mainly traded on two exchanges that we've already looked at, the CME and LME. 

The CME is a USA-specific market and the price reflects American prices, whereas the LME is a global copper market and the price reflects international price changes. 

Here's how you can get involved with trading copper.

 

How to invest in copper

Your options to invest in copper are broadly similar to that of oil; in the futures markets, with ETFs and mutual funds, and buying stock in mining companies

Although you can buy rolls of copper wire or bundles of copper piping, the price is pretty low - as you can see below - if you were looking to physically trade copper, large quantities are needed because of the low value.  

Image Source: Macrotrends

Trading CFDs or futures contracts for copper means you can buy large quantities without having to consider storage and transportation of all that metal. 

Another option to take advantage of the price of copper is an EFT such as the United States Copper Index Fund (CPER) or a mutual fund like Vanguard Materials Index Fund Admiral Shares (VMIAX) which invests in industrial metals and other resources. 

 

The last commodity we're going to look at is a little different.

 

Commodity #4: Wheat

Wheat is an agricultural product and its price is very environmentally dependent

Droughts or flooding can severely affect the price of wheat and any other soft commodity. 

Since food is perishable, futures contracts can be more short-term and are mainly popular before harvest. 

As well as the supply and demand for wheat and other grains determining the price, government policies can affect how much you'll pay for a bushel. 

Photo by Melissa Askew on Unsplash

 

Some governments will subsidize the price of wheat to ensure that prices are stable for the public. 

In the USA, for example, the government will buy wheat for programs like the  Bill Emerson Humanitarian Trust (BEHT) and the European Union's Common Agricultural Policy aims to control how much wheat and other crops are grown through subsidies

If you want to trade in agricultural commodities, here's how you can do it.

 

How to invest in wheat

As with the other commodities we've looked at, there are a few different routes to invest in wheat. 

You can invest in wheat futures through the trading symbol WHEATF

There aren't a lot of ETFs that specifically trade in wheat, but the Teucrium WEAT fund is an option. 

To be indirectly involved in agricultural commodities, you can consider investing in stock for companies in that sector, such as Caterpillar (CAT). 

Image Source: Yahoo Finance

As well as making mining and drilling equipment, Caterpillar produces heavy equipment for farms. 

Investing in a company like Caterpillar can expose you to the farming commodities market without having to closely follow crop prices. 

Now you know how some commodities can be traded and have seen some examples of commodity stocks, we're going to walk you through how to start investing in these commodities.

 

Step-by-Step Process for Trading Commodities

You can start your journey to buying and selling commodities by starting commodity trading online

We've given you a broad overview of commodities here so you can understand if they're markets that you want to start opening positions in. 

You should always work to understand the commodities, ETFs, or stocks you want to invest in and think carefully about your risk tolerance before you make any investment decision. 

Here's our step-by-step guide so you can start trading commodities.

 

Step #1: Decide what kind of commodities you want to invest in

Different commodities have different factors that determine their prices. 

The determiners of commodities prices range from geopolitical issues and natural disasters to wider economic issues in the USA and further afield. 

While there are many commodities available to you, you will have fewer options than trading forex or stocks. 

Further, some commodities can be seen as a long-term investment, like gold or silver, whilst food commodities tend to trade short-term futures contracts. 

Understand what level of risk you want to work with and which markets you want to study as your first step to trading commodities. 

After you decide where to put your money, you need to know how much you'll be investing.

 

Step #2: Set a budget for your investment

There is a risk that you can lose money when you trade commodities, just like when you invest in stock or forex. 

It's important that you understand your budget and your disposable income so that you have the cash to pay your bills, pay loan payments, and pay into your retirement fund before you start to invest money. 

Once you know how much spare money you have for investing, you should consider setting limits when it comes to losses. 

Particularly when you invest in commodities futures, you may be required to fund your position with more money if the contract drops below your position, known as a margin call. 

If this happens, you need to be comfortable with your trading strategy and be ready to fund or close your position, depending on your budget.

 

Step #3: Open an investment account

The next step to start investing in commodities is to open the accounts you'll need to make trades. 

To trade commodities, you'll need to open a brokerage account and a trading account with a trading platform like ZuluTrade.

When opening a brokerage account, you need to check that:

  • The brokerage is registered with the Commodity Futures Trading Commission (CFTC)
  • The brokerage will be able to trade the commodities you want 
  • The brokerage is compatible with the trading platform you want to use
  • The pricing structure and minimum investments are clear so that you know your costs

 

Once you choose a broker that offers what you're looking for, it's time to open up your trading account.

Some of the things you want to look for when opening a trading account include: 

  • How user-friendly the platform is
  • The pricing structure it uses
  • Whether you can follow the positions of experienced traders
  • The information available such as historical charts and trading guides

To open an account with ZuluTrade, simply complete your details


… and decide if you want to open a real account or a demo account to start. 

If you need to wait for your brokerage account to be confirmed, you can open a demo account and begin to learn about the interface before you start trading for real. 

You can upgrade your demo account to a real account at any time and link it with your live brokerage account. 

Accounts opened, it's time to start making decisions about your trading.

 

Step #4: Choose your investment method

Once you have a trading account set up, you're ready to start commodity trading.  

Which method you choose will depend on your investment strategy - are you going to trade futures contracts or buy stock in a company within the commodities industry? 

On the ZuluTrade platform, you can choose either of these investment methods. 

You can also decide if you're going to manage all of your positions personally or if you want to have your funds follow the trades of successful traders with Copy Trading

You can choose to have some or all of your money copy the positions of a Trader on the ZuluTrade platform, including traders who invest in commodities. 

 

There are also Traders who take positions in stock… 

… including trading in companies like ExxonMobil:

To find a Trader who works with the stock or the commodities you're interested in, you can use the filter function, that looks like this:




Here, you can select the codes for the stocks and commodities you're interested in.

Now you've chosen how you're going to invest in commodities, it's time to make your first investment.

 

Step #5: Take a position

Now you're ready to open a position and begin trading. 

To follow a Trader on ZuluTrade, you simply find the trader you want to follow and select Follow. 

You'll be asked to choose how much of your cash you want to use to copy their trades and your risk appetite:

 

Once you click Follow, your account will begin to mirror all of the Trader's positions

Want to make your own trades as well? 

Before starting to invest, you should plan your trading strategy and complete fundamental and technical analysis to test your strategy. 

Once you're comfortable with your chosen strategy, you need to go into your trading account and select the symbols you want to trade: 

Author's note: This screenshot is taken from a demo account in the ZuluTrade platform

Then, you click on the price for the commodity you want to open a position for; in this case, we're going to select gold, which is XAU/USD.

Next, you enter the details of how much you want to invest and any limits you want to set. 



Once you click OK, you'll have successfully opened your position. 

That's how you can start trading commodities, now you need to keep a check on your investments.

 

Step #6: Manage your investment portfolio

You should actively manage your positions, whether you've chosen Copy Trading or manual trading, or a mix of both. 

The stock market is volatile and markets can change quickly - you need to actively assess your portfolio regularly and ensure that your chosen strategy is working. 

Track your investments in your ZuluTrade dashboard, where you can see all the details of your open positions. 

Keep up to date with market news, which could include information about the weather, international politics, and the global economy - all of which influence the supply and demand of commodities and the prices. 

That's our step-by-step guide to investing in commodities, let's close this out.

 

Now Over to You

That's your guide to getting started with online commodity trading. 

In general, it does feel similar to forex or stock trading, although there are different factors that determine the prices of commodities. 

Whether you're looking to trade commodities to add diversification to your investment portfolio or you want to focus on commodities only, it's a simple process to get started. 

Ready to trade commodities? 

Open an account with ZuluTrade today and get started.


Disclaimer: The views expressed do not constitute investment or any other advice/recommendation/suggestion and are subject to change. Reliance upon information in this material is at the sole discretion of the reader. Opinions expressed in this article do not represent the opinion of ZuluTrade Social Trading Platform and do not constitute an offer or invitation to anyone to invest or trade. Every metric and the statistical number is a result of a past performance which does not constitute a promise or a certainty for a future one.

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Trading spot currencies involves substantial risk and there is always the potential for loss. Your trading results may vary. Because the risk factor is high in the foreign exchange market trading, only genuine "risk" funds should be used in such trading. If you do not have the extra capital that you can afford to lose, you should not trade in the foreign exchange market. Forex Brokers and ZuluTrade are compensated for their services through the spread between the bid/ask prices or there may be a cost to initiate a trade through the bid/ask spread. Signing up is totally free, and there is NO contract and NO monthly fees, ever.

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