Commodities are often an overlooked component of an investment portfolio but can help investors better diversify their portfolios and smooth out returns.
This is because many commodities have recorded positive returns over the long run and often act as a hedge against inflation (and the stock market itself).
There are 4 main ways that you can invest in or trade commodities:
Each of these methods has its own benefits and drawbacks, but all require you to first have a trading account with a broker or trading platform before you can start investing. It's possible to start investing in commodities with as little as a few dollars if you trading commodity stocks or ETFs.
But if you're looking to trade more complex instruments like commodities derivatives or futures, higher minimum trading amounts will apply, and you'll also need to pass a quiz before you can trade derivatives and CFDs in Australia.
Commodities are basic natural resources such as oil, food and metals. They can be thought of in some ways as the basic building blocks of our economy.
Commodities are most often used in the production of goods and services. This includes the raw materials used in manufactured finished goods or resources used to produce energy.
There are 2 main categories of commodities: hard commodities that need to be mined or drilled to be found, such as metals and energy products and soft commodities, which are grown, like corn and wheat.
There are dozens of commodities that can be traded via futures and derivatives markets, as well as specific ETFs:
You can choose to invest in a commodity by purchasing the physical commodity itself.
In Australia, you can do this by looking for a dealer or service that sells the commodity and purchase it from them.
Of course, once you buy the commodity, you'll need somewhere to store it. So while this is possible with commodities like gold or silver, it's probably not realistic if you want to invest in commodities like wheat, livestock or lumber, unless you also happen to have a warehouse handy.
This is why investors often prefer to invest in commodities via the futures market, as we explain below.
This is probably the most common way to trade commodities. With futures contracts, you are agreeing to purchase a certain commodity at a specified point in the future. This means you can potentially profit from price movements in either direction.
Futures contracts were originally created to assist commodity traders and sellers (like farmers), who would start growing a type of commodity, such as wheat, long before it could actually be sold to help hedge against any financial risk in the case that the harvest was bad or the price of wheat crashed.
Nowadays, futures markets are extremely sophisticated and highly liquid, with more than 137 billion contracts traded in 2023 alone.1 You can purchase futures contracts in just about anything, including popular commodities like gold, oil, wheat, soybean, gas and copper.
Physical commodities trading is only available to advanced traders or corporations. In Australia, retail investors can trade commodities via contracts for difference (CFDs). These are derivatives contracts where you're not actually trading the underlying commodity, instead, you're speculating on the price movement of the commodity.
Derivatives traders typically use leverage, which can make CFDs a lot riskier than stock trading and it's possible to lose all your money. Before you consider trading CFDs, it's important that you fully understand the risks involved and have a clearly defined trading strategy.
"Start by defining clear, realistic financial goals based on your risk tolerance and time horizon. From there, drill into how you are going to achieve those goals with your chosen investing strategy. Getting the right education will ensure safety in your endeavour whilst also fast-tracking your success."
You can follow the steps below to start trading commodities futures and derivatives:
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
ETFs are an accessible, low-cost way to get exposure to different commodities or commodity sectors without having to buy and hold the underlying assets or having to deal with complex financial instruments like futures contracts.
Most commodity-based ETFs are funds that track either a basket of companies that operate in a certain commodity sector (such as mining companies or agriculture), but there are also ETFs that solely track the price of a specific commodity. like the Invesco DB Oil Fund (NYSEArca: DBO), which tracks the price of crude oil, or the Betashares Gold Bullion ETF – Currency Hedged (ASX: QAU), which tracks the price of gold.
There are quite a few commodity ETFs that trade on the Australian Securities Exchange (ASX), but many others trade on global exchanges. If you're looking to trade a particular ETF, make sure you signed up with a platform that offers access to the exchange that lists the ETF in question.
Using the Invesco DB Oil Fund ETF example above, you'd need to find a platform that lets you trade on the NYSE Arca exchange if you wanted to invest in that particular ETF.
Important: The standard brokerage fee displayed is the trade cost for new customers to purchase $1,000 of either Australian or US shares. Where a platform charges different fees for both US and Australian shares we show the lower of the two. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
Another way to get indirect exposure to commodities is by investing in companies that produce, trade or manage the commodities themselves.
Say you wanted to invest in lithium. It's probably not feasible for you to buy and hold lithium yourself, but it is pretty straightforward to invest in lithium mining companies. This way you can potentially benefit from appreciating lithium prices without having to own the physical commodity.
However, it's worth keeping in mind that commodity stocks are influenced by more than just the value of the underlying commodity, including the company's financial performance and prospects, the volatility of the stock market and even wider macroeconomic factors.
You can invest in commodity stocks using a standard share trading platform.
Commodity volatility (how much the price moves up and down) is generally reflective of supply and demand. If there were loads of avocados grown just as everyone decided they didn't like guacamole anymore, then the price of your average avocado is likely to go down. If a worldwide virus leads to everyone panic buying toilet rolls, you're likely to see the price rise.
Due to supply and demand, the volatility of commodities tends to be higher than for other types of investment, but this depends entirely on the commodity.
All investing carries risk, but many commodities are items that consumers continue to buy even in a recession. Commodities can be relatively volatile, which is why they're popular with traders, but the level of volatility will vary across different commodities and sectors.
The type of commodity investment you make will also have an influence on the level of risk you'll be taking on. There's a huge difference between the risk profile of a mining company stock and that of a crude oil futures contract, for example.
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