Investing in commodities is especially relevant during times of inflation. Why?
Inflation is the general rise in the price of items that are consumed by individuals and businesses - essentially a rise in the price of commodities
When prices of commodities rise, individuals cut down on consumption, and businesses see declining demand and lower profits
Markets come under pressure, and making money by either saving or investing becomes super hard
In these times, when the prices of commodities are rising, doesn't it make perfect sense to just invest in them? And that’s why commodities are the perfect hedge against inflation.
Unfortunately, it’s not easy as investing in stocks. Commodities are more volatile, they involve much more effort to understand and even transact in.
Which Commodities Can You Buy?
There are four major types of commodities:
Agriculture: grains and pulses such as corn, rice, wheat
Precious metals: gold, silver, platinum
Energy: crude oil, natural gas
Metals and minerals: steel, aluminium, nickel, zinc
How Do You Get Exposure to Commodities?
You can get commodity exposure by transacting in one of the following instruments:
Commodity Futures: Futures are a standardised agreement to buy or sell the underlying asset at a pre-determined price on a specific date. The underlying asset can be a stock, currency, commodities or an index. Futures contracts based on the price of a commodity can be bought and sold on exchanges. For this, a brokerage account is necessary. The most used exchanges in India are NCDEX for Agri commodities and MCX for non-Agri commodities.
Physical Purchase: These transactions involve buying tangible items like gold and silver, either in the form of jewellery, coins, or bars. This is more suitable for high-value commodities like precious metals, as the storage cost of some commodities may run high. You can’t buy a tonne of wheat and get bothered with storing it in a warehouse under certain conditions and managing its transportation.
Commodity Stocks: You can also invest in stocks of businesses that deal in commodities, such as those of an agricultural company, an oil refinery, or a company that makes steel or aluminium. Compared to actively wagering on commodities prices, this may be less dangerous. However, most commodity companies buy a commodity in some form, refine it and then sell it further. So they do get impacted by spreads between the buying and selling between raw materials and the final product.
Mutual funds: A commodity fund is a fund which primarily invests in commodities, offering returns to investors based on the market performance of the commodity chosen. For example, a mutual fund company might offer a commodity fund which deals only in gold, with fluctuations in gold prices having a direct impact on the fund and the returns it offers. This is professionally managed, and you can get exposure to smaller amounts.
Commodity ETFs: Exchange-traded funds (ETFs) based on commodities operate just like mutual funds. unlike mutual funds, they trade on exchanges too. Essentially, they can offer better liquidity, price discovery, and the ability to trade derivatives on. However, currently, in India, the only ETFs available are for gold and silver.
What’s the Best Way?
Instrument | Exposure | Ease of Investing | Ticket Size | Cost | Liquidity | Professional Management |
|---|---|---|---|---|---|---|
Commodities Futures | All Commodities | Low | High | High | High | Low |
Physical Purchase | High-value commodities (Gold, Silver, Platinum etc.) | Medium | Low | High | Medium | Low |
Commodity Stocks | Through listed companies dealing in commodities | High | Low | Low | High | Low |
Mutual Funds | All Commodities | High | Low | Medium | High | High |
Commodity ETFs | Limited to Gold & Silver | High | Low | Low | High | High |
Conclusion
Although investing in commodities may seem confusing at first glance, it is really just another option for investors seeking portfolio diversification and improved inflation protection.
With the popularity of storing gold in bank lockers, and in the form of jewellery, physical purchases have been topping the charts in India. However, if one has to consider factors like liquidity, transferability, costs, quality and reliability, this option doesn’t really seem too attractive.
Overall, however, for new and beginner investors, it's just better to hand over the decision-making to experts by investing in mutual funds or ETFs. That way, the professionals can do their job whilst you are able to invest your money with peace of mind.
Commodity stocks and futures would require a certain level of expertise, which if you don't have it, is best avoided.