Trading or Investing in Commodities
Buying commodities for long-term investment has become increasingly popular in recent years. The emergence of commodity exchange-traded funds (ETFs) has made this process much easier. There are also other investments, such as managed futures, that can generate profits regardless of the direction of commodity prices. If you are investing in commodities using a certain percentage of your investment portfolio, timing is not necessarily as crucial as it is in commodity trading.
The two most common times when investors turn to commodities are when commodities become very cheap and are seen as an investment opportunity. The other time is when commodities reach high levels after many years, and investors want to capitalize on these trends. In fact, most asset classes attract the largest amount of investment dollars after they experience a period of high returns. Sometimes this is a good philosophy, but often investors buy at the market’s peak.
Commodities, at their core, are a hedge against inflation. Over decades, commodities generally keep pace with or exceed the rate of inflation. Therefore, a buy-and-hold strategy makes sense, regardless of when the investor buys commodities.
When trading commodities, many strategies can be used to take advantage of price trends. One of the most common strategies is trading on a scale when the price of the commodity reaches its lowest level over many years. Once the commodity drops below the cost of production, the theory suggests that the price probably won’t decline much further and that a major bottom is near.
Commodity traders do not necessarily need rising commodity prices to make money. Commodity trading allows traders to enter and exit markets easily with futures contracts, as well as profit from declining commodity prices. Traders typically employ a specific trading strategy and capitalize on short-term price movements in commodities.
The Best Time to Buy Commodities
There is no definitive formula for the best time to buy commodities, just like with stocks. It really depends on the investor’s time horizon and investment objectives. Buying low is often the best path in my opinion if you have a long-term investment outlook.
The gold market is a good example. Gold reached $850 per ounce in 1980, an extraordinary price for that period. Many investors were buying gold during the hysteria and found themselves purchasing at a high price that would not be reached again for 28 years. On the other hand, gold prices hit their lowest levels in many years in 1999 near $250 per ounce. This price was close to or below the cost of production and may have been near the market’s bottom. Then, gold prices rose over the next decade, surpassing the previous highs of 1980.
Not all markets behave like the previous example, but it represents a good illustration of commodity markets. Sometimes it takes longer to change prices, but they often do change. When investing in a commodity index, it becomes a bit more complicated since some commodities may be near their highest levels over 10 years while others may be near their lowest levels over 10 years. If you can perform a simple market analysis, there are many avenues to allow you to invest in individual commodities.
Commodities as an Investment
Just as an investor buys stocks in an investment portfolio for long-term returns, the same can be done for commodities. Whether commodities are at their highest levels over many years or at their lowest levels, an investor can enter the market at any time. Returns should be successful over a holding period of two decades if you purchase a broad commodity index. Remember that commodities are often seen as a hedge in an investment portfolio. If commodities perform poorly for a certain period, it is likely that other investments in a diversified portfolio are doing well.
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References:
– Federal Reserve Bank of San Francisco. “Commodity Prices and Inflation,” Page 27.
– FRED Economic Data. “Effective Federal Funds Rate.”
– Goldprice. “All Data Gold Price in USD/Oz.”
Source: https://www.thebalancemoney.com/the-best-time-to-buy-commodities-809217
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