Commodities are one of the most important asset classes; however, most people haven’t even heard about them. How is this possible? Well, there is nothing sexy about talking about commodities.
Before we dive into everything commodities, I’d like to welcome you back to the Become a Bonafide Investors series (Part I, part II, Part III). This series strives to give you advanced information on the investing world. Now, let’s jump back into the world of commodities.
What are commodities? From Investopedia; A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. Producers use commodities as inputs to the production of other goods and services.
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Some commodities include grains, corn, soybeans, wheat, milk, cocoa, coffee, sugar, oil, and natural gas. To trade commodities, sellers and buyers exchange contracts for a specific amount on a specific date.
This is all pretty standard stuff, so to unlock the value in commodities, you must understand how important they are to supply and demand. First, let’s talk about the history of futures contracts.
In the 1800s, in the Chicago area, there was a huge market for grain. However, grain elevators (where they store grain) were limited, leaving storage and transportation as major obstacles to getting grains to market. Many farmers would lose money because of oversupply and bad road conditions to Chicago.
On the flipside, after harvest, there was so much supply they would dump grain into Lake Michigan. If only there were a way for the farmer to sell his grain at a certain price point in the future. That way, there would be no price shock at harvest.
Enter futures contracts. Futures are contracts for commodities that are set sometime in the future. Futures allowed the farmers to safely bring their grain to market and predict profits on a reasonable timeline.
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Futures contracts allow farmers to hedge against weather conditions, bad crops, and market changes. Producers can use futures to price protect (lock in rates) their crops. In the 1800s, this allowed farmers to produce crops without worrying about fluctuations in price safely. There is an excellent example of hedging on Investopedia.
Futures contracts also allow non-producers to get involved in the commodities markets. These investors are called speculators, and they look to make a profit between the fluctuations in prices—this is called the futures market, and it is a beast.
I read the book “A Trader’s First Book on Commodities” to make sense of the commodities market. To be honest, I haven’t even touched the surface of the world of commodities. Yet, I persist because Robert Kiyosaki tells me that commodities are their asset class.
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So now we understand that commodities are essential goods that producers trade on the commodities market. Futures are commodity contacts that exchange for future delivery. Producers and speculators use futures contracts to hedge and speculate with these goods. There is a lot of money to be made in commodities and futures if you understand the world.
But unless you want to dedicate 4-6 hours a day to learn this new world, I would not recommend you to get directly into commodity trading. The book explains that it is prohibitively expensive to trade commodities, and most fail to make money. It is an adult world, with adults losing money every day.
But there are ways to involve yourself with commodities; you just have to know-how. But why would a standard investor care about commodities? Commodities are an excellent hedge against inflation.
Inflation occurs when there are too many dollars and not enough goods and services. For example, say the government gave everyone in America $2,000. Now, everyone wants to buy the new 70 inch TV. The TV price would increase because everyone has money to buy it, and there are not enough TVs to go around. This is inflation—supply and demand.
Commodities are a function of supply and demand, so a conversation about commodities usually follows when you talk about inflation. Let’s take a quick look at how the timber market affected the housing market in 2021.
Due to the pandemic, mill shutdowns, and surging demand, prices of timber (a commodity) began to sky-rocket. CBNC says that due to the increase in the cost of timber, new homes prices shot up by $36,000. The housing market has a lot of demand and not enough supply, and timber prices exacerbate the situation.
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So we want to invest in commodities, but going directly into the commodities market can be dangerous for green investors (us). How do we involve ourselves with commodities then? We invest in companies that deal with commodities for us. In the case above, we buy companies that deal in timber, or we buy homebuilders.
Seeking Alpha has an excellent article on some Timber REITs that could be good commodity plays. By researching companies, businesses, ETFs, and REITs that handle commodities, you can get exposure to the markets.
I own a farmland REIT called Gladstone Land Corp (GLAD), which exposes me to crops and land. You can see the picture above; the price of GLAD spiked along with inflation fears—bringing me to another point; commodities are cyclical.
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Right now, commodities are in short supply and high demand—meaning prices are high. However, they have on-cycles and off-cycles, and knowing both can make you rich. I am buying and holding several companies that work in commodities, like Exxon Mobil (XOM), which deals in oil.
I will dollar-cost average into these positions for the long term, with no intention of making a quick commodities play. However, sometimes it can be good to take profits, and there is no better time than the top of a super-cycle.
There is so much to talk about with commodities, so this is just the beginning. There is nothing sexy about coffee and corn futures, but you can leverage these vehicles to your success if you speak the language.
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If you want to become a Bonafide investor, you need to speak the language of inflation, commodities, currencies, options, etc. I recommend reading the book “A Trader’s First Book on Commodities.” It is a long book, but it will give you valuable history and information on the complex world of commodities.
Remember, I invest in businesses that handle commodities. This shields me from dealing directly with the markets. The companies will also follow the path of the cycles, so be warned—they go up and they go down. Welcome to the beautiful world of commodities; I will have more to follow. Enjoy and Happy Investing.
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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