How to invest in commodities

Commodities play an important role in the economy. Some people invest in commodities to benefit from their use in the production of everyday necessities, while for others they’re simply a store of value. If you’re thinking of investing in commodities to diversify or protect your portfolio, then there are several considerations you’ll need to make.

A commodity is a raw material or natural resource which is typically traded in order to produce a good. For example, wheat (a commodity) is used in the production of bread (a finished good). Alternatively, oil (a commodity) is used in the production of petrol (a finished good). This is what differentiates a commodity from a product, and you’ll generally find that when commodity prices rise this has a knock-on effect for its respective products.

However, investors don’t always trade commodities with the view that their resources will be used in the production of everyday items. Gold, for example, can be seen as a store of value and hedge against inflation. If you buy a gold coin, then you’ll hold onto this tangible good over an extended period and only sell it when you see fit.

Before you invest in a commodity it is worth doing your research and evaluating how it is used in everyday life. As a starting point, it’ll likely either be classed as a soft or hard commodity.

Soft commodities are grown and cultivated, like sugar, wheat and livestock. Think of them as resources which can be produced on a farm.

Hard commodities are extracted from the earth and include silver, coal and gold, to name a few.

This depends on the commodity you’re trading and how it is traded.

Generally, because increased commodity prices can lead to pricier goods, some economists argue that investing in commodities is most rewarding in periods of rising inflation.

In the UK, the general rise in the price of goods and services is measured against a basket of goods set out by the Office for National Statistics (ONS). Most of the items in this basket of goods are tangible items, not services like insurance policies and driving lessons. So, when the price of goods increases, you should see the price of commodities used in production increase too.

Of course, this is a generalised look at the price of commodities. Once you delve into the makeup of each specific commodity you’ll note that there are a range of unpredictable political and geographical factors which impact their prices.

Some commodities can be owned outright. For example, and as mentioned, you can own a gold coin and keep it in a safe until you wish to sell it.

However, other commodities aren’t that easy to obtain and store. Take oil; it is a regulated commodity and only licenced companies can buy it directly. Plus, even if it could be bought then how would you store a barrel of oil?

Despite these challenges you can still invest in these types of commodities through stocks and investments such as Exchange Traded Funds (ETFs).

One way of investing in commodities is to invest in the companies which mine, farm or produce these resources.

However, you won’t always see a direct correlation between the price of your commodity and stock. For example, if you decide to invest in a company which supplies energy, the price of natural gas won’t be the only variable which affects its stock price. Its stock could still fall if it mismanaged its finances or if there was a company-wide scandal.

An ETF is an investment which is designed to track the performance of a segment in the market. Like an index-linked fund, it achieves this by investing in a range of stocks and bonds in this sector. You can learn more about ETFs in our guide.

There are some ETFs which aim to track the performance of a commodity or set of commodities.

Like stocks, commodity prices won’t be the long variable which will affect your investment. Company performances and investor appetite will also play a role in the price of the ETF.

Gold is one commodity which isn’t only used in the production of goods but is also viewed as a store of value. Over time it has kept up with inflation, and you can read more about its history by reading our guide.

Oil is used to produce fuel, which is then used for transportation. It is no surprise then that when the price of oil rises, transportation costs tend to follow suit. Not only does this mean it becomes more expensive to fill up your car, but it also makes it more expensive to move goods across the globe. This sometimes feeds into higher inflation overall.

Wheat is an agricultural commodity which is used in the production of bread. It is also an unpredictable commodity because unforeseeable events, such as a drought, can affect its share price.

If you’re looking to invest in commodities which could play a role in supporting a green future then there are several commodities you can consider.  

Lithium is a key resource used in making batteries. It could be a key commodity to add to your portfolio as many countries aim to promote the use of electric vehicles.

Not only is copper used in the production of electric vehicles, but it is a key commodity in the production of solar and wind power. As countries try to wean off their dependence on oil, coal and gas, in the future copper could be a key commodity in creating eco-friendly infrastructure.