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Beginner Commodity Tips – The Basics of Commodity Stocks and Prices

In the most recent episode of the Investing for Beginners Podcast, Andrew and Dave talk about investing in commodities and talk about some different experiences that they have had doing so.  Drawing back on their experiences they were able to come up with a few commodity tips that I want to dive a little deeper on!

So…commodities – what are commodities?  You might remember the term ‘commodity’ from school as a raw material that is essentially sold entirely on price and there is no substantial difference from the quality of one source to another. 

You likely have heard oil or gold being referenced before as commodities and while those are two very common commodities, there are other commodities as well, such as:

  • Energy – not just crude oil but natural gas, heating oil, etc.
  • Metals – gold, silver, copper, etc.
  • Agriculture – corn, coffee, cotton, beans, etc.
  • Animals/Livestock – all types of various animals such as hogs, cows, etc.

Typically, when people talk about commodities, they seem to be talking about trading them.  That is 100% my own biased opinion, but I very infrequently hear people that are actually investing in commodities. 

When I talk about investing, I want to find a good investment that I can put money into and not worry about for many, many years down the road.  With commodities, they seem much more volatile and the opportunities seem to be more short-term focused.

But if you’ve decided to invest in commodities, and I don’t think that’s necessarily a bad thing, I recommend you pay attention to these tips below to make sure that you’re setup for success:

  • Stay within your circle of confidence
    • This is not only a tip for commodities but a tip just in general.  Always focus on investing in things that you know.  If you invest in what you know then you’re going to immediately be a step up on some others because not everyone sticks to that, and I would even venture to guess that many people get wrapped up in the hype and invest in something that they do not know.
    • If you want to invest in something that you don’t know, then learn about it and then invest in it.  I think this advice is even more important with commodities because you need to understand how their market prices are impacted because it is not similar to normal market fundamentals with stocks.
  • Understand that the market prices for commodities are primarily based off supply and demand
    • Yes, there obviously is a cost for all commodities, but the prices are typically based off of supply and demand rather than a sort of fundamentals that you’re likely used to.
    • Anytime that some sort of crisis happens that might impact the supply, you’re going to see the prices of these commodities skyrocket.  Andrew highlights this with the prices of pork back when there were huge concerns about the Swine flu and there has been a great example very recently with the war concerns in Iran.
    • Recently, Iran launched a missile attack on some US Troop bases in Iran.  When the market closed the day of these attacks (but before the attacks occurred) the price of Crude Oil was $62.61.  After these attacks had become known to the world, the price of Crude Oil spiked.  Big time.  It went from $62.61 up to $65.48, an increase of 4.6% in a matter of hours.  The next morning, Trump came out and said that nobody was killed in the attacks and that the US strongly prefers to not engage in a war, the price of crude oil sank back down to $60.37 at the close the next day, a decrease of 8.5% from the high and 3.7% from the prior day close. 
    • So, in a span of 24 hours, we saw the price of crude oil spike by 5% and then decrease by 8.6% all because of speculation that supply might tighten.  That is not trading on fundamentals whatsoever – it’s 100% speculation.
  • Supply and demand can be impacted by many things
    • As I previously mentioned, the supply and demand of a commodity is what really impacts the prices of that commodity.  This can be impacted by many things – war, disease, natural disaster, terrorism, anything!  The fact of the matter is to understand that this is an unpredictable investment and that if you’re not comfortable with the risk, then you should stop considering commodity investing immediately.
  • If you’re going to investing in a company that heavily leans on commodities, you should at least understand the basics of how commodities work
    • This can apply to many companies such as an oil company that purchases crude oil, a steel company, a coal company, a food company that relies on livestock – anything!  You don’t need to know the ins and outs, necessarily, but the more you know, the better.  It’s great to understand the company’s balance sheet but if their main Cost of Goods Sold is a commodity, then I would certainly be sure to understand the different potential circumstances that could drastically change the impact of the company.

You might read these tips and think that I am completely against this – and you’d be wrong!  I think that as long as follow these tips then commodity investing can be a fantastic form of diversification. 

Most of my tips really boil down to one thing – understanding what you’re investing in.  You need to understand what makes the price change, potential risks to the commodity, potential future opportunities for it, and then try to think ahead a little bit! 

You’re about to invest in livestock – well, what do you think about the impact of people moving to vegetarian options?  You want to invest in oil – well, what do you think about the impact of electronic vehicles?  These are all the types of questions that you should have a clear vision on about what YOU think is going to happen.

As long as you know what you’re investing in and you have conviction, then investing in commodities can be a great tool for your portfolio.  If you don’t have an appetite for volatility, then maybe you should consider something a little bit less risky…but hey, as Lil Wayne said it best, “scared money don’t make money.”