Commodities are standardized resources or raw materials that have inherent value and are used to create finished products. They can be classified as any tangible item that can be bought and sold, with the exception of financial instruments and currency. Although the quality of commodities may vary, they must be largely consistent on certain criteria across different manufacturers. The two types of commodities that are available in the market are hard and soft commodities.
Hard commodities are the kind of resources or materials that can be used to create their products, such as metals and minerals. Soft commodities are the materials that are meant for initial consumption, like agricultural products.
Investing in commodities
There are multiple ways to invest in commodities. One option is to acquire physical raw commodities, such as gold or silver bullion. Another way is to invest through futures contracts or exchange-traded products that mimic a specific commodity index. Even though many people use these types of investments, they tend to be highly volatile and complex. Therefore, it is recommended for experienced investors who know how market trends work.
Another method to invest in commodities is through mutual funds that invest in companies that are related to commodities. For example, an oil and gas mutual fund would own stocks of companies involved in energy exploration, refining, storage, and distribution.
The pros and cons of investing in commodities
If you are planning to invest in commodities, here are some of the pros and cons that you should know about:
Pros:
Diversification: Commodities and related stocks tend to have returns that are not correlated with other stocks and bonds. This means that a portfolio that includes these assets may be less affected by market fluctuations. Diversification can therefore help manage risk, but it does not guarantee a profit or protect against loss.
Potential returns: Individual commodity prices can change based on factors such as supply and demand, currency exchange rates, inflation, and economic conditions. In general, when commodity prices increase, the stocks of companies in related industries also tend to perform well.
Potential hedge against inflation: Commodities have historically performed well during periods of high inflation, as inflation can cause the value of stocks and bonds to decrease. However, it's important to note that commodities can be more volatile than other types of investments.
Cons:
High volatility: Since the price of raw materials fluctuates depending on market supply and demand, investing in commodities can be highly volatile.
Speculation: Since the commodity price is highly volatile, it also tends to attract people seeking short-term profits. The actions of large groups of investors, known as speculators, can greatly impact the price of an asset.
Foreign and emerging market exposure: In addition to the risks inherent in investing in commodities, funds that people use to invest in commodities in foreign or emerging markets also carry the risks associated with those markets, such as political, economic, and currency instability, which can lead to greater volatility.
If you want to invest safely in commodities, you can enroll in Nifty Trading Academy and learn more about the market.