What is the best way to invest in commodities?

The commodity markets offer opportunities for traders of all sizes, strategies, and risk aversion levels. However, before you put money to work in commodities you must be aware of two simple, but often overlooked facts:

1. Trading is not investing. Understanding, the difference between these two approaches is important because the allocation of your assets should be overweight in investments, and underweight in trades.

2. Putting money to work, whether you do it as a trader or an investor, in the commodity markets is far different than doing so in traditional asset classes such as stocks and bonds.

Trading vs. Investing

Trading is active speculation on price changes; traders might go long or short a market in anticipation of relatively short term moves. Investors, on the other hand, are the so-called “buy and holders” whose purpose is to accumulate gains on a long-term basis, namely several months or even several years.

Although there are no guarantees or assurances, investors typically face better odds of success in the long-run than active traders might. However, they do so with expectations of relatively lower profit potential. Naturally, savvy and experienced traders might fare better than traditional investors but they are undoubtedly accepting higher levels of risk to do so.

In general, investors are putting their money to work in asset classes that have historically provided price appreciation and might even pay dividends or interest payments. Investors typically don’t use leverage and should be seeking modest, or at least realistic, returns.

Traders often speculate on leverage and are indifferent to the historical tendency for prices to move in a particular direction. Case in point, commodities tend to trade in long-term ranges and cycles. Aside from low levels of inflation, commodities are not necessarily expected to appreciate in the long-run like equity securities are.

Accordingly, traders face far less room for error. An investor that is early, or wrong, can simply hold a position for several months or years if necessary in attempt to recoup losses, but a trader rarely considers this as an option. There is a saying in the trading business that goes something like this, “an investment is a speculation gone wrong”.


More about different ways to invest in commodities in the April 2014 issue of Stocks & Commodities Magazine...

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