Introduction to Commodities Investing

Module 1: The Joy and Importance of Understanding Commodities

Learning Objectives:

• Define the fundamental elements of commodities.

• Understand how learning more about the commodities market will make you a more intelligent investor.

Commodities are raw materials or primary agricultural products used in commerce. They are typically fungible, which means they are interchangeable with other commodities of the same type. For example, one troy ounce of pure gold from the USA is the same as one troy ounce of pure gold from Australia.

Commodities play an important role in our daily lives. Every time you walk into a supermarket or the mall, you are surrounded by commodities that are traded around the world. Examples include the cotton in your clothing, the metals in your electronics, the food you eat, and the fuel in your car.

There are four broad categories of commodities:

• Agriculture: E.g. Cocoa, Coffee, Corn, Cotton, Soybeans, Sugar, Wheat

• Livestock: E.g. Feeder Cattle, Live Cattle, Lean Hogs

• Metals: E.g. Gold, Silver, Platinum, Copper

• Energy: E.g. Crude Oil, Heating Oil, Natural Gas

The relatively obscure and perhaps intimidating asset class of commodities is often ignored by investors, especially retail investors. However, it is both fascinating and important to understand how this market works. Even if you do not invest in commodities directly, understanding the dynamics of this market will help you become a more intelligent investor overall.

A company’s profitability and therefore stock price are influenced by the costs of the raw materials used in producing their goods. Understanding the supply and demand dynamics of relevant commodities can help you learn more about the future prospects of a business. Mining companies, for instance, typically benefit greatly when the market price of the mineral they are extracting increases.

Several major currencies around the world are highly correlated to the performance of key commodities in their economy. Australia is one of the world’s top three producers of gold, and from 1999 to 2008 the Australian dollar had an 84% positive correlation with the price of the precious metal.

Commodities provide you with a whole new asset class to consider when looking to protect and grow your wealth. And a deeper understanding of this market will enhance your ability to identify investing opportunities and threats across a number of asset classes.

The availability and cost of crude oil influences the lives of billions of people. A simple example can illustrate this point: A reduction in the world supply of oil may increase fuel prices. This could increase the price of retail goods, as elements in the supply chain become more expensive. All else equal, inflation increases and the buying power of consumers’ money decreases. This is one of the reasons why politicians sometimes put pressure on OPEC to increase its production of crude oil.

Besides the practical advantages of understanding the commodities market, a great level of satisfaction can be found in acquiring a better understanding of how the world functions. International news becomes more relevant, and you begin to better understand the rationale behind decisions made by leaders and politicians. A functioning international commodities market is vital to the survival of many economies around the world.

Take Action

There are many commodities and it can quickly become overwhelming if you try to follow too many too closely. Select a specific commodity and begin learning! Listen to interviews and podcasts, read blogs and articles, and learn from experts with high levels of knowledge and experience. Always be humble, and always be hungry for knowledge. The world’s most successful investors are learning machines!