"Commodities" is a broad term referring to raw materials and produce; metals like silver, gold and copper; and crops like corn, soybeans and grains. Making money in commodities is not easy. About ninety percent of commodities traders lose money rather than make it. One reason commodities trading is difficult is that there is no right time to enter or exit the market. It is essential for you to understand the market. You must also learn how economics can affect commodity prices. There are many ways to invest in commodities, including the futures market, buying options on futures contracts, the actual commodities (gold and silver are examples of easy-to-store commodities), Commodity ETFs (exchange-traded funds), and buying the stock of companies whose business model involves commodities. This article will highlight the commodities futures market. You must decide what futures contracts you want to buy, study the charts and develop your trading strategy.
- Understand physical commodity transactions. Commodities are raw materials, agricultural products, petroleum products, and industrial and precious metals. Physical commodities are bought and sold in bulk for immediate delivery in specialized markets around the world. These markets are known as the "spot" or "cash" market. The majority of participants in the spot market are producers, and users of the commodity, able to finance and store large amounts of a commodity such as a refinery buying crude oil or a flour miller buying wheat and corn. As a consequence, individual investors rarely purchase any physical commodity except precious metals like gold, silver, platinum. or palladium. An individual taking delivery of a physical commodity must be prepared to:
Pay a premium over the spot price, whether purchasing coins or bullion. Premiums can range up to 25% of the spot prices.
Pay cash for the total purchase price. If an investor wishes to leverage his purchase, he must find and negotiate with a private lender who is willing to accept the metal as collateral.
Pay extra charges for storage and insurance to protect against theft.
Assume the risks of illiquidity. Finding a buyer for a large amount of gold, for example, might be difficult and expensive[1]
- Buy or sell physical commodities. You can buy physical commodities by visiting specific websites or exchanges where they are sold. They are not available through standard brokerages. Finding reputable markets to buy in can be difficult, however. Look for well-known authorities to point you towards safe places to trade physical commodities.
For example, the World Gold Council maintains a list of reputable sites selling gold coins and bullion.[2]
Store your physical commodities. Physical commodities need to be stored in secure locations until sale. You can also buy insurance to protect you from a total loss if the commodities are stolen. Both of these increase the cost to the investor and cut into potential gains.
Some gold-selling companies offer secure storage for buyers.
Understand the basics about commodity futures. Commodity futures are contracts to make or take delivery of a specified amount of a commodity at a predetermined price at a specific future date. Futures trade on specialized financial markets where delivery is due on a future date. Futures contracts are available for a variety of different commodities ranging from bushels of wheat and corn to barrels of crude oil or ethanol. Each futures contract has two parties, one to make delivery of the commodity and the tether to take delivery.
A buy order is a contract to take delivery of the commodity while a sell order is a contract to make delivery of the commodity.
Commodity futures and spot prices are tracked in the market just like other assets. Traders make money by buying commodities (or commodity derivatives) for a certain price and then subsequently selling them for a higher price.
The buyer of a futures contract makes money if the future market price of the commodity exceeds the market price of the commodity at the time of purchase. A seller of a futures contract makes money if the future market price is less than the market price of the commodity at the time of sale.
Rather than making or taking physical delivery of a commodity, futures traders close their positions by implementing a contrary position to offset their liability to make or take delivery. For example, a buyer of a contract would sell the contract before delivery date while the seller of a contract would buy the contract.