Ordinary investors typically are not able to purchase raw commodities in large amounts. Even if you were able to buy commodities, such as barrels of oil or bales of wheat, you would need to invest in transportation and storage. For example, if you believe oil prices will continue to rise, you could buy shares of Exxon/Mobil, which generally rise with the price of oil.
Example of a Commodity Stock
Gold mining stocks can be attractive because they offer a “leverage effect” to the price of gold. A gold miner has a cost to extract the metal, which includes the cost of running the business. When the price of gold is greater than the cost of extraction and continues to rise, gold mining profits rise faster. Hypothetically, if the cost to extract the metal is $1,000 per ounce and the price of gold is $1,100 per ounce, the company has a $100 profit. If the price of gold rises from $1,100 per ounce to $1,120 per ounce, that represents a price increase of almost 2%. The gold miner’s profit, however, rises from $100 per ounce to $120 per ounce, which is a 20% increase in profits. The stock price of the gold miner rises based on its increase in profits, which is 10 times higher than the increase in the price of gold. Leverage can also have a negative impact. For example, if the price of gold decreased by 2% to $1,080 per ounce, the profits would decrease by 20%. The stock price of the gold miner would drop to reflect the decrease in profits.
Pros and Cons of Commodity Stocks
Pros Explained
Easy access: All you need to buy commodity stocks, exchange-traded funds (ETFs), and mutual funds is a brokerage account. Commodity accounts require margin, often have higher fees and minimums, and may require financial qualification. Diversification: Commodity stocks offer exposure to the commodities market without directly investing in commodity futures, which are volatile and short term. Dividends and capital appreciation: Like many other stocks, commodity stocks may offer the value of ownership, the potential for dividends, and capital appreciation.
Cons Explained
Volatility: The commodities market is volatile, which may be reflected in the individual commodity stock.Correlation: Commodities are ways to diversify your portfolio, because their prices typically don’t correlate, or move, in the same direction as other asset classes such as stocks and bonds. Commodity stock prices, however, are not just influenced by the price of the materials; the price also is affected by broader stock market and economic trends, as well as news and events specific to the company.
Types of Commodity Stocks
Commodity stocks fall into three categories of commodities: agricultural, natural resources, and financial instruments.
Agricultural
Agricultural stocks supply feed, fertilizers, grains, seeds, and biomaterials to companies that grow, refine, and distribute food and other products such as natural health and beauty aids. Archery-Daniels, Cargill, and Bunge are examples of large-cap agricultural commodity stocks.
Natural Resources
Natural resource stocks include energy and metals.
Energy commodity stocks: These companies supply, refine, and distribute oil, gasoline, and natural-gas products. Energy commodity stocks include Exxon/Mobil and ConocoPhillips.Metals: There are two types of metal commodity stocks. Mining companies explore for and extract metals. Mining stocks include companies such as Rio Tinto and Barrick Gold. Junior mining companies explore for new sources of metals, while senior mining companies have established reserves. Royalty commodity stocks provide capital to mining companies in exchange for a portion of the production.
Financial Instruments
Financial instrument commodities include currency, cryptocurrency, and financial index products such as S&P 500 index futures. Unlike other financial instruments, some cryptocurrencies such as bitcoin use a “mining” process to create and distribute new cryptocurrency.
How To Invest in Commodity Stocks?
Buy Stocks Directly
All you need is a brokerage account to buy individual commodity stocks. Many brokerage companies offer research resources to help you identify and analyze individual stocks, mutual funds, and ETFs.
Invest in Mutual Funds and ETFs
Mutual funds and ETFs are ways to diversify and buy shares in many different commodity stocks. Mutual funds and ETFs often have low minimums. Mutual funds and ETFs are purchased using a brokerage account. The expenses of ETFs and mutual funds can vary depending on whether they are actively or passively managed. Always research before you invest.
Invest in Derivatives
Derivatives such as stock options derive their value from the underlying asset. Stock options are ways to control a large number of shares with relatively small sums of money. Stock options can be used to speculate on the price direction of a commodity or other stock.
What It Means for Individual Investors
Ideally, a portfolio should be diversified and include assets that don’t correlate or move in the same price direction. Commodities are attractive because the prices generally are not correlated with stocks and bonds. Commodity stocks can offer portfolio exposure to commodities, as well as the benefits of dividends and capital appreciation. However, some research suggests that commodity stocks track more closely with the broader stock market than the actual underlying commodity. Commodity stock ETFs and mutual funds are low-cost ways to get diversification and exposure to many different commodity stocks.
