Commodity Investment Tips For Beginners

Analyst — Wed, 14 Jul 2010 08:39:35 +0000

Commodity market is an inflation indicator of an economy, as it shows the price index of commodities. Hence, if you are planning to invest to hedge yourself against inflation, you must consider investing in this market.

Commodity market can sometimes be quite volatile, but so can be the stock market. The idea is to diversify you investment in varied products, and into the ones not similar to your existing investment. You must expand your portfolio and allocate funds to various asset classes to minimize risk and get decent returns.

The Market

The commodity market comprises of 48 markets from all over the globe, and trades around 96 commodities. People can trade anything from gold, silver, coal to spices, stell and orange juice. One of the biggest commodities market in the US can be found in Chicago. Size of the market may be small. But Chicago Mercantile Exchange (CME) trades in big volume everyday.

Before we actually discuss strategies to invest in commodities market, let us first understand what a commodity is. It can be an oil barrel, gold bar, orange juice, food grains like wheat or rice, and so on. However, gold and oil are the two commodities that contributes most of the trade in this market. When the economy of a country is not performing well, people withdraw money from other assets and invest money in gold.

However, CME is different from a grocery store. It’s not a market where farmers sell their product with cans full of soybeans. Instead, commodity market deals in future contract. In such a contract, you agree to buy a commodity at today’s price at some time in future. This is similar to gambling, and price fluctuation in short term is purely based on speculation.

How to Invest in Commodities as an Average Investor?

First, you will have to decide whether you want to trade or invest in commodities. Trading is certainly risky, and should be done only when you are well-versed with the market, strategies, and factors affecting prices of commodities.

Investing in commodities is a good way to diversify your portfolio. As most of the commodities in this market are inflation-protected, this is a better option during tough economic times.

There are several ways to invest in a commodity. The easiest way, however, is to invest through ETF’s (Exchange Traded Funds). Here are few examples on how you can do it.

SPDR Gold ETF

This is one of the most profitable and reliable commodities in the market. Hence, it is preferred by most individual investors. Besides, this fund is 6th largest holder of physical gold in the world. Most people invest in this fund to receive decent returns during downturns. Hence, having SPDR Gold ETF in your portfolio balances your investment proportionately.

PowerShares

If you have enough gold in your portfolio, you can put some money in PowerShares, which is an ETF diversified in soybean, wheat, corn, and sugar. When prices of these four commodities go up, value of this ETF increases.

Once you are well-versed with this market, you can start trading in these commodities and deal in future contracts. However, make sure you seek advice from an existing trader.

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Oileconomics: Does Dollar Weakness Cause High Oil Prices

Analyst — Mon, 09 Nov 2009 04:28:57 +0000

With the Oil price hitting new high of $82 per barrel last month the focus is again on the impact of dollar weakness on oil prices. Last month also saw the US dollar falling to new lows against basket of currencies. So how is that the dollar weakness causes high oil prices.

Theoretically oil prices are determined by three factors:

Current supply in terms of output, especially the production quota set by OPEC.
Oil reserves, including what is available in U.S. refineries and what is stored at the Strategic Petroleum Reserves.
Oil demand, particularly from the U.S. (as estimated by the Energy Information Agency)

With the US dollar being the currency of choice in global crude oil trade, dollar devaluation creates several problems for the world oil industry. Oil producing countries receive their oil revenues in US dollars but use other currencies to buy goods and services from different nations. International oil companies sell their crude oil in US dollars while they operate around the world using local currencies to pay for wages, benefits, taxes, and various costs. Consumers in countries with non-dollar appreciating currencies enjoy cheap oil, while people in dollar-pegged countries pay a higher price for the same barrel of oil. Therefore, dollar devaluation affects world oil supply and demand.

Take for instance country X that receives say $75 a barrel for oil from all countries of the world. This $75 is then used by country X to buy goods and services from other countries. With no inflation around, the income of country X in US dollar is unchanged. However with the fall in the value of dollar the income of country X in its currency or in the currency of its trading partners has decreased. Also other countries whose currencies have appreciated are enjoying a discount on their oil with the fall in the value of dollar. This discount can only be removed by letting the $ price of oil to rise to compensate for the fall in the $. Also maintenance of the same purchasing power in the domestic currency mandates an increase in oil price in $ terms. Thus decline in dollar’s value results in oil prices in dollar terms.

Theoretically, dollar devaluation also reduces drilling activities in oil producing countries. All other things being equal with dollar depreciating these countries purchasing power is reduced fuelling domestic inflation levels. Dollar devaluation by making oil cheaper in other currencies increases demand for oil in countries with non-dollar appreciating currencies. Regardless of OPEC decisions, dollar devaluation on its own tightens supplies, increases demand and keep oil prices high for an extended period of time.

Oil prices have increased only in dollar terms. In other currencies the increase in oil prices is not so steep. So why price oil in dollar. Oil is entirely global so why not accept different currencies from different countries? These are questions which are being raised by many emerging economies like Russia, China and Brazil. Recently Russia and China have agreed major oil and gas deals that may well be priced in either the Rouble or the Yuan. Iran is also trying to price its oil in euro terms. This move will further devalue dollar. With the fall in the use of the U.S. $ in the oil market, the excess dollar held in central bank reserves of various countries will be released into other markets which would be unable to absorb them. If this practice were to continue and other oil producers accepted currencies other than the U.S.$ more dollars would flow into the foreign exchange markets of the world, where they will prove too much and the $ will further fall relative to other currencies.

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