How to invest in commodities

Introduction

Commodity investing can take several forms. An investor might own physical gold, buy an exchange-traded product linked to commodity prices, invest in a mining or energy company, or use futures contracts.

These methods are not interchangeable. Each provides a different type of exposure and introduces its own costs, risks, and practical considerations.

Before investing, it is useful to understand what the investment actually owns, how closely its return is connected to the underlying commodity, and what can cause performance to differ from changes in the spot price.

Why invest in commodities?

Investors may consider commodities for several reasons. Commodity prices are driven partly by physical supply and demand, so their behavior can differ from stocks and bonds. This can make commodity exposure relevant to diversification.

Some investors also use commodities to gain exposure to particular economic themes, such as energy demand, industrial growth, precious metals, or agricultural shortages.

Commodities are sometimes associated with protection against inflation. Certain commodities can benefit when raw-material prices are rising, but no commodity provides a guaranteed inflation hedge.

Main ways to invest in commodities

The most appropriate way to gain exposure depends partly on the commodity. Physical ownership is realistic for precious metals but generally impractical for crude oil, crops, or livestock.

Investing in physical commodities

Direct physical ownership is most common with precious metals. Investors can buy bullion bars or coins and hold the metal themselves or arrange professional storage.

The advantage is straightforward exposure to the physical asset without depending on a company’s operations. However, the quoted commodity price is not necessarily the price an individual investor pays. Dealers typically buy and sell at different prices, creating a spread, and some products trade at premiums to their metal value.

Storage and insurance can add ongoing costs. These considerations become especially important with lower-value commodities. For example, storing a given dollar value of silver generally requires considerably more physical space than storing the same value of gold.

Commodity ETFs and exchange-traded products

Exchange-traded products can make commodity exposure easier to access. Investors can generally buy and sell shares through a brokerage account in much the same way as other exchange-traded securities.

The important question is how the product creates its exposure. Some precious-metal products hold physical bullion. Many products linked to oil, agriculture, or other difficult-to-store commodities instead use futures contracts.

Expenses, liquidity, legal structure, collateral arrangements, and the method used to track the commodity can all affect returns. Investors should therefore look beyond the product’s name and understand what it actually holds.

For more background on the fund structure itself, see our guide to what an ETF is and how ETFs work.

Investing through commodity-related stocks

Another approach is to invest in businesses that produce or process commodities. Examples include gold miners, oil producers, agricultural companies, and businesses that provide equipment or services to commodity industries.

These investments are stocks, not direct ownership of commodities. A higher commodity price may improve a producer’s profitability, but that outcome depends on the company’s costs and operations.

A mining company can suffer production problems. An oil producer may carry significant debt. A business may hedge its output and receive a different price from the current market price. Management decisions and broader stock-market conditions can also affect returns.

Commodity stocks can therefore move more or less than the underlying commodity and may occasionally move in the opposite direction.

Commodity futures

A futures contract is a standardized agreement to buy or sell a specified quantity of a commodity at an agreed price for a future date. Futures are widely used by producers and commercial users to manage price risk and by traders to gain market exposure.

Futures typically require only a portion of the contract’s total value to be posted as margin. This creates leverage. A relatively small commodity-price movement can therefore produce a much larger percentage gain or loss on the capital committed.

Contracts also expire. An investor who wants to maintain exposure must generally replace an expiring contract with another contract for a later delivery month. This process is often called rolling the position.

Why futures-based returns can differ from spot prices

A futures-based commodity investment does not necessarily produce the same return as the commodity’s spot price. The prices of contracts for different delivery months can vary.

When longer-dated futures are more expensive than near-term contracts, the market is commonly described as being in contango. Repeatedly replacing cheaper expiring contracts with more expensive later contracts can create a drag on returns.

When longer-dated contracts are cheaper than near-term contracts, the market is in backwardation. Rolling contracts can be more favorable in this environment.

This effect is particularly important when evaluating futures-based commodity funds over longer periods.

Comparing commodity investment methods

Examples across commodity markets

The practical investment choices differ by market. Gold and silver can be held physically, while exchange-traded products and mining stocks provide alternatives.

With oil investing, physical ownership is generally unrealistic for individuals. Futures-based products and energy stocks are more common routes.

Agricultural commodities and livestock commodities are also primarily accessed through futures, funds, or related businesses rather than direct physical ownership.

Costs to consider

The cost of commodity exposure depends on the investment method. Physical ownership can involve dealer spreads, storage, insurance, and shipping. Funds charge operating expenses and may incur trading or futures-related costs.

Stock investors face normal trading costs and the economic costs associated with the underlying business. Futures traders need to consider commissions, bid-ask spreads, margin, and the consequences of rolling contracts.

Taxes can also differ by investment structure and jurisdiction. Investors should understand the tax treatment that applies to a specific product rather than assuming all commodity investments are taxed like ordinary stocks.

Risks to understand

Commodity prices can be volatile because weather, geopolitics, inventories, currencies, economic conditions, and unexpected supply disruptions can change quickly.

The investment vehicle can introduce additional risks beyond the commodity itself. Leverage can magnify losses, futures-based funds can experience tracking differences, physical assets require secure storage, and commodity-related companies face normal business risks.

Our guide to the risks of commodity investing examines these issues in more detail.

Key takeaways

• Investors can gain commodity exposure through physical ownership, exchange-traded products, commodity-related stocks, and futures.
• Each method provides a different type of exposure and introduces different costs and risks.
• Futures-based investments can perform differently from spot commodity prices because contracts expire and must be replaced.
• Commodity-related stocks are businesses and do not provide the same exposure as owning the underlying commodity.
• Leverage makes direct futures trading significantly more complex and can magnify losses.
• Understanding the structure of an investment is essential before comparing its performance with a commodity price.