Investing in Commodities

How does investing in Commodities work? Is it safe? How much return can one expect from trading in commodities?
Commodities are raw materials that are sold in bulk and include:
• Grains – Corn, Soybeans, Wheat 
• Livestock – Cattle, Hogs 
• Precious Metals – Gold, Platinum, Silver 
• Industrials – Cotton, Copper 
• Softs – Cocoa, Coffee, Sugar, Orange Juice 
• Energy – Crude Oil, Heating Oil, Natural Gas 

Onions are specifically excluded from the commodity list based on a 1958 law. Financial commodities include currencies, treasury securities, and stock indexes. Investors typically buy and sell commodities with options and futures contracts. Commodity prices can be tracked in The Wall Street Journal or The New York Times. The most popular way to monitor futures contracts for the generic commodities market is through an index known as the Commodities Research Bureau (“CRB”) Index which is the most widely followed basket of commodities in the world. 

Investing in commodities is usually done through futures contracts that are traded on an exchange and guarantee the delivery of a certain commodity at a predetermined price on a future date. There are three ways these investments make money:

o Spot-price movements: Spot price is the price one would pay to buy the commodity in the market today. If there is an increase in a commodity's spot price, an investor would gain if he sells the commodity. 
o Roll yield: Roll yield works when the commodity's futures price is lower than its current spot price which is often the case. As the futures contract approaches its delivery date, the contract's value converges to the new spot price. It then rolls over into a new contract with a lower futures price. And the investor picks up the yield between the lower futures price and the higher spot price. 
o Collateral income: The fund investors do not have to spend much money to buy the commodities. They use some form of a derivative contract to mimic the returns of the index which requires only a small amount of assets, so the funds have cash left over to buy bonds. Those bonds can add incremental return.

To invest in commodities, you will have to meet certain net worth requirements and place your cash in a brokerage margin account. Commodity prices often swing wildly. So, while you can make lots of money, you can also incur huge losses in a short period of time. Do not invest money in commodities that you cannot afford to lose. While the gains you make may be spectacular, be prepared to lose your investment in a highly volatile commodities market. Commodities are one of the most volatile investments available.

Commodities’ trading is one of the riskiest investment activities and can be compared to lottery tickets. The Commodity Futures Trading Commission (CFTC) describes commodities trading as a "volatile, complex, and risky business." It is not for everyone. 
Do not invest all your money in commodity markets but make it a part of a diversified investment portfolio. 

A somewhat safer way to buy commodities is to invest in a mutual fund that buys and sells commodity futures. The major funds that trade in commodities market include the Pimco Commodity Real Return Strategy D and the Oppenheimer Real Asset fund. An investment in a fund like this limits your loss to the amount you have invested. 

Commodities often benefit from inflation over the short term and long term, because when the price of goods and services increases, the prices of the commodities needed to produce the goods and services also increase. Gold markets also benefit from inflation. In struggling economies or geopolitical uncertainty, gold prices have historically risen since consumers and institutions buy gold perceiving it as a "safe haven," or a true store of value.