Investing In Natural Resources Can Save Your Assets – Commodities Investing Series
July 25, 2008
What does investing in natural resources mean?
When you choose to invest in natural resources (also known as commodities) you are investing in the building blocks of civilization.
In other words, commodities are materials that we use to make the finished products that we buy. Fritos are not a commodity, but the corn they are made from is. Jewelry is not a commodity, but the metal it’s made from is.
Other examples of commodities include: Oil, wheat, sugar, coffee, cocoa, orange juice, natural gas, and precious metals.
Just think of all the things that our ancestral traders traveled far and wide to acquire! Today we are not much different. We still need many of the same things, and as long as we do, there will always be a steady market for commodities.
So, how can commodities save my assets?
Adding commodities to your investment portfolio performs one simple (but valuable!) task. It offsets your risk. There will always be a market for wheat, corn, and gold. There may not always be a market for the next big Dot.Com, and that brand new cure-all drug could turn out to cause Jekyll and Hyde symptoms. When you have commodities safely in the backseat of your portfolio you are free to take a little more risk in other areas.
So, how do I start investing in commodities?
Investing in commodities can be as hard, or as easy as you want to make it. You can take on large amounts of risk and hope for a quick profit, or you can take very little risk at all and use commodities to stabilize your overall portfolio.
Here’s a rundown of some of the ways you can add commodities to your portfolio:
Commodity Mutual Funds:
A Commodity Mutual Fund is a professionally managed fund where investors pool their money and buy stock together. Because mutual funds are professionally managed, they have to pay the manager. Sadly, the management fees alone can eat up your profits pretty quickly. Also, in order to invest in most mutual funds you required to have at least $1,000 to invest. Because of the high fees, low yield, and high price of getting into the funds, I typically prefer Exchange traded funds.
Exchange Traded Funds (ETF’s):
ETF’s also buy groups of stocks. However, instead of a group of individual investors pooling their own money, ETF’s usually have backers with deep pockets who put up the money for the funds. Then, they give investors the ability to buy shares in the fund itself, rather than it’s individual stocks.
It’s kind of like buying into someone else’s pre-diversified portfolio. This way, you don’t have to take the risk, or have the money, to invest in all of the oil companies in America. The fund does it for you, and you buy into the fund. It’s cheap, and instant diversification. ETF’s also have very low management fees, so you have more of a profit margin when the fund does well.
This is the type of commodity investing that I believe will save your assets in the long run. You may never make an enormous profit quickly, but you can usually expect reasonably solid, steady performance.
Of course, I am not an all-powerful wizardess that can predict the future of the market, and I can’t leap tall buildings in a single bound either. Your mileage may vary. See your doctor before beginning any exercise program.
For a list of just a few of the Natural Resource ETF’s available you can visit this site.
Now, we are talking about a lot more risk with this one. Always remember that when you put your money into a single company, you had better be sure it’s a worthy investment. After all, if the company goes under, so does your money!.
That said, there are an unbelievable variety of individual companies you can buy into. In fact, if you pick a commodity; let’s say, oranges, you can invest in companies that handle nearly every stage of their growth and production. You can choose to invest in the orchards themselves, or in the companies that distribute the finished products to your local supermarket – whatever sounds most attractive to you.
No article on commodities would be complete without a mention of Futures. This is an extremely high risk method of investing. Not too many brand new millionaires walk out of Vegas, and for every person who makes a mint buying futures there are thousands if not hundreds of thousands of people crying all the way to the bank. So. Be warned. Don’t expect this type of trading to offset the risk in your portfolio. This would be the risk in your portfolio.
How it works: Futures contracts are speculations, pure and simple. When you purchase stocks or bonds you do actually own something tangible, even if it is only a small percentage of a company or a debt. When you purchase a futures contract you do not actually own anything at all. Instead you are betting that the price of a given commodity (like coffee) is going to rise in the future. If you thought the price of coffee were going to fall in the future, you would sell your contract.
So why would anyone do this? The Reality Based Trading Company has an excellent example on their web site.
On one side of a transaction may be a producer like a farmer. He has a field full of corn growing on his farm. It won’t be ready for harvest for another three months. If he is worried about the price going down during that time, he can sell futures contracts equivalent to the size of his crop and deliver his corn to fulfill his obligation under the contract. Regardless of how the price of corn changes in the three months until his crop will be ready for delivery, he is guaranteed to be paid the current price.
On the other side of the transaction might be a producer such as a cereal manufacturer who needs to buy lots of corn. The manufacturer, such as Kellogg, may be concerned that in the next three months the price of corn will go up, and it will have to pay more than the current price. To protect against this, Kellogg can buy futures contracts at the current price. In three months Kellogg can fulfill its obligation under the contracts by taking delivery of the corn. This guarantees that regardless of how the price moves in the next three months, Kellogg will pay no more than the current price for its corn.
For more information on the buying and selling of futures contracts, you can visit this site.
In the next article we’ll talk a little about how to research potential investments step by step, so stay tuned!
What do you think is the best way to invest in natural resources? You can give us your opinion below!
Trading Places promotional photo courtesy of Paramount Pictures. 1983
All posts by Connie Brooks