Everything You Need To Know About Investing in Commodities

Aug 2, 2022

Everything You Need To Know About Investing in Commodities

The majority of Indians depend on commodities in their daily lives. Commodities such as grains, energy and fuels, gold, natural gas, and other soft commodities like coffee are good examples of everyday commodities.

However, commodities can also be a powerful asset-class for investors to diversify their portfolios outside traditional equities. High-risk investors turn to commodities many-a-times during phases of market turbulence and volatility. The reason for such a move might be to temporarily move away from stock markets or ride out the bearish phase in equities.

In early times, investing in commodities was the domain of professionals and financial experts. You need to understand that commodity investing is a complex tool and needs significant amounts of time, money, and knowledge. But, the internet opened the market for millennials and new investors who have a high-risk tolerance and don’t fear burning their hands. This led to new developments in the commodity market. And MCX, which is one of the largest Indian Commodity Derivatives Exchange was formed. Since then, MCX has been the catalyst to further enhance the commodities segment in India.

So let’s ponder over some of the very basic ideas about commodities and investing.

What Is a commodity?

In the days of barter trade, a commodity was considered as any good that can be exchanged for another. So ideally, it was more of a mode of exchange in terms of trade and commerce in the old days. Before the invention of stock trading, commodity exchanges (although not formal ones) have been around since the dawn of humankind. Commodities are the raw materials utilized to create various products and services that are then offered for sale on the open market.

But today, investing in commodities contributes to portfolio diversification. It’s because they tend to move in the opposite direction of stock markets. Studies say that commodities remain in a bearish phase or trade sideways when stocks are bullish and vice-versa.

ProTip: This cannot be a thumb-rule for your trade decisions but can help you understand the nature of markets and how they tend to move in different economic cycles.

What is the commodity market?

Typically, a commodity market is a venue where people can trade goods for prompt deliveries with others living in the same nation. Here are the main benefits of investing in commodities:

  • Creates short-term and long-term investment opportunities.
  • It assists in portfolio diversification.
  • It gives you an advantage in resisting the economy’s inflation rates.
  • Mitigation of the risk.

However, with the introduction of MCX exchange for commodities, today it is possible to trade in commodities without having to take physical deliveries of such goods. Cash-settlement on the basis of market values has replaced the physical settlement in earlier times. This was one of the factors that contributed to the furtherance of commodity investing in India.

Why Should You Invest in Commodities?

Diversification

Diversification is a tool that does not guarantee success, but protects against market losses to a extent. Similar to P2P lending that offers a cushion for your investments and diversifies your risk of investments, commodities can help you protect the downfall from other asset classes such as equities. This is only if you have a high-risk tolerance. Such diversification results in an optimized investment portfolio. You have a better control over handling volatility among various markets that don’t move in sync.

Potential profits

Prices for specific commodities can change due to factors like supply and demand, inflation, currency rates, etc. For example, the rising demand for big international infrastructure projects has affected commodity prices recently. So in favorable economic scenarios your portfolio can benefit greatly from such price appreciation.

Potential inflation protection

Commodity prices can increase due to inflation. Typically, commodities tend to perform better during high inflation periods. However, they can be equally unpredictable. So if you believe that the present inflationary scenario will result in high commodity prices, you can consider investing in the asset class.

Types Of Commodities

1. Agricultural

Among the world’s most significant food crops – wheat is also one of the most important agricultural commodities. Other examples include cereals, coffee, sugar, cotton, etc..

2. Energy

Energy products primarily include crude oil and natural gas that are traded in MCX. Other commodities include diesel fuel, propane, coal, electricity, etc. These commodities are widely used in industrial manufacturing purposes and transportation, and to a extent for household purposes.

3. Metals

Metals include copper, the most used type of electrical wiring. Silver, gold, iron, nickel, lead, zinc etc. are other examples of metals most of which are openly traded in MCX.

Risks of Commodity Investing vs P2P Lending:

Principal risk

Commodity investing can be a risky business. The asset class has multiple factors affecting the prices of various items. Such events can be anything from global economic conditions, import restrictions, international competition, governmental laws, and FX rates, etc. all which can impact commodity prices. As a result, commodity prices can be pretty volatile. If you’re unable to track a lot of these events, it’s best to stay away from this asset class.

In comparison, your principal stays protected to a larger extent when you invest in P2P Lending. This is due to the fact that LenDenClub distributes your money among a large pool of borrowers which in some cases can go to as low as 1 Re. per borrower. And the chances of all these borrowers defaulting are close to nil!

Volatility

While the prices of commodities are highly volatile, mutual funds or exchange-traded products (ETPs) that follow a specific industry or commodity may also display higher volatility than usual. Moreover, when it comes to capital requirements, the margins required to trade in commodities are quite high. So, while profits can be significant the same holds true for losses if your trade goes awry.

Since Peer-to-Peer Lending is a non-market linked asset-class, you don’t see wild swings in your investments. This feature makes P2P one of the best investment opportunities for investors looking for relatively safe investments with high returns in India.

Geo-Political Tensions Always Go Wrong with Commodities

The geo-political tensions, economic and currency instability, competition to capture a large market share etc. are some of the external factors that deter the prices of commodities. These factors are out of our control and all we can see is such factors leading to large losses on our portfolio. But, it’s great to know that none of these factors can impact P2P lending investments leaving your portfolio shock-proof from such an environment.

Other risks

Generally speaking, derivatives contracts are utilized by commodities-focused funds to follow an underlying commodity or commodity index. Thus, it is possible for a fund’s performance to diverge from the performance of the underlying commodity while trading in these speculative, volatile instruments. Depending on the market and the fund’s investment strategy, that difference may be either favorable or negative.

Conclusion

Both new and seasoned traders can invest in various financial products that allow them access to the commodity markets.

While commodity futures contracts offer the most direct way to follow market price changes, other less risky investment options also provide enough opportunities for commodity exposure.

But as we already saw, commodity investing can prove very risky and not understood thoroughly.

So, after reading this if you feel that you’re not built for commodity investments, try investing in P2P Lending. LenDenClub, one of the largest P2P marketplace in India, offers solid returns averaging up to 10 – 12%*! Become an online money lender today.

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