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Diversify, diversify, diversify is a message investors repeatedly get from financial experts. Equity, fixed income and real estate are well-recognised asset classes that investors take exposure to, depending on their time horizon and risk appetite. However, when it comes to commodities, many of us rarely think beyond gold. 

But did you know that commodities can help you not just diversify your investment portfolio but may present some exciting moneymaking opportunities?

Table of contents

Basics of commodities

How are commodities classified?

What affects commodity prices?

How to invest in commodities? 

Basics of commodities as an asset class 

At their core, commodities are used as raw materials in various manufacturing processes, and in some cases, they are consumed directly as well. But commodities aren’t a very homogeneous asset class and the classification of commodities holds the key. Let’s learn about it in greater detail. 

You can classify commodities into three groups

  1. Precious metals: gold, silver, etc.
  2. Industrial commodities: oil, metals, and chemicals 
  3. Soft commodities: agri commodities such as edible oils, rubber, tea, coffee, etc.

Some of you might prefer to classify commodities differently—based on whether they are primary outputs or have been obtained through value addition. For instance, iron ore is a commodity obtained through mining; however, steel is a secondary or value-added commodity. Similarly, crude oil is a primary commodity whereas petrol and other downstream chemicals are secondary commodities. 

What affects commodity prices?

Barring pure agriculture commodities, the demand-supply dynamics of commodities are greatly affected by the performance of an economy. Hence, barring a few exceptions, commodity price movements are highly cyclical. Some commodities are global, which includes almost all industrial metals, precious metals and energy sector commodities. They have greater implications. 

At times, commodity price inflation rips through household budgets and poses a threat to corporate profitability as well. On other occasions, low commodity prices wreak havoc among commodity producers. This makes any investment in the commodity market a highly risky proposition. The primary factors that affect the prices of commodities are:

  1. Inflation
  2. Cost of Production
  3. Demand and supply
  4. Currency fluctuations
  5. Interest rates
  6. Geopolitical factors
  7. Import
  8. Weather 
  9. Global economic growth
  10. US Dollar Exchange rate
  11. Speculative trading
  12. Technology
  13. Natural Disaster

How to invest in commodities?

  • You can physically own a commodity—e.g. you may buy gold coins and silver bars
  • Invest in commodity Exchange Traded Funds (ETFs) or commodity mutual funds
  • Exchange Traded Commodities (ETCs) targeting a specific commodity 
  • Other securities targeting a specific commodity—e.g. Sovereign Gold Bonds (SGBs)
  • Investing in Alternate Investment Funds (AIFs) investing in commodities 

There is also a passive way to invest in commodities. You may invest in stocks of commodity-producing companies or invest in mutual fund schemes investing specifically in mining companies and catering to other commodity producers. 

How to trade commodities? Through derivative contracts — Futures and Options (F&O). You may either trade in index derivatives targeting a group of commodities or a specific commodity. Moreover, you may use an app or a web trading platform. 

In summary

Your investment in the commodity market can help you diversify your portfolio, capitalise on opportunities available in specific commodities and shield yourself from the ill effects of commodity inflation. 

Please remember: It is mandatory to have a separate demat account for commodity trading. If you still don’t have a commodity account required for commodity trading, you may consider opening one with Ventura. 

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