Commodities

Common stocks represent an interest in the earnings of a company--what's left over after all the sales have been made, and all the bills paid.  The end of the line, so to speak.  Commodities are just the opposite--they are the raw materials that go into making food, automobiles, and a myriad of other products.  What investors like about commodities is that their prices do not correlate with the Dow-Jones average, the S&P 500, the Russell 2000 or the stock market in general.  So if an investor's stock portfolio is in the dumps across the board, his investment in commodities can still be doing well.  On the other hand, commoditiy prices are buffeted by weather, catclysmic events, political upheavals and other difficult-to-predict events, and prices can move quickly, so it's not prudent to load up heavily on commodities.  But there is a place for them in most intelligently allocated portfolios of investible assets.

So how do you invest in commodities?  Investors do not buy actual pork bellies (aka bacon), bushels of wheat, or 25000-pound units of copper.  They buy (or sell) contracts that obligate them to buy or sell the actual commodity at some specified time in the future.  Then before that date arrives, they sell (or buy) the contracts to offset the original purchase.  This does not mean that the commodities are never delivered or  any of the contracts ever fulfilled because wheat farmers, for example, will deliver their wheat as contracted.   In the beginning of the growing season farmers calculate their costs, and if they see prices for wheat in the month when they expect to harvest that will give them a profit, they can lock in those prices.  Similarly, consumers of commodities can protect themselves against price hikes.  Airlines, for example, will buy futures on jet fuel well into the future to protect themselves against hikes in the price of oil.

Trading in commodity futures requires an investor's constant attention and is inherently risky.  Speculators love it because leverage is built into the system.  To enter into a contract, you only need 10% of the face amount of the commodity under contract.   For example, to control 1000 barrels of oil valued at $50,000 you would only need to put up $5000.  If the price goes up ten percent so that the contract is worth $55,000, you have doubled your money. Similarly, if it drops ten percent you are wiped out!

You can buy and sell commodity futures through discount brokers like eTrade  and Charles Schwab, or investment firms like Merrill Lynch and Smith-Barney.  But a more prudent wait to gain exposure to commodities is through a commodities fund which is managed by a professional commodities investor.