Should I invest in commodities?

John W. Schoen Senior Producer • Profile • E-mail

Like a lot of novice investors, Jeanette is curious about investing in commodities — but she hates the idea of losing money. Which makes her a bad candidate for rolling the dice with the pros speculating in the future price of oil or pork bellies.

I am relatively new in investing. I want to know if investing in commodities such as sugar, oil and stuff like that is a safe investment. I am willing to invest a substantial amount of money, but would be sick if I lost it. Can you please advise me?
— Jeanette H.

There are plenty of good reasons to bet on commodities, but if you’re new to investing that’s probably a better way to think of it: as a bet. Since you’ll be betting against experts who do this for a living, your odds probably won’t be much better than playing the slots in Atlantic City.

Commodities speculation is about the riskiest place to deploy your savings: it’s really in a different category than investing. Commodities exchanges are really supercharged betting parlors made up of a series of hyperactive markets where you can bet on the price movements of a variety of products. The list includes precious metals, raw materials, grains and meat, oil and gas — even financial products like Treasury bills.

Though they carry big risks for individual investors, commodities markets were originally set up to help spread the risk of price changes among a large pool of players. Using futures contracts, for example, a farmer can sell a crop before it’s planted, even though he might get a better price in the future (which is where the name comes from.) If a boom in demand drives up prices by harvest time, the buyer of the futures contract wins. But if a bumper crop floods the market and prices plunge, our speculator could lose everything. No matter what happens, the farmer has enough money in the bank to buy the seed for next year's crop.

This risk-shifting helps big consumers of commodities, too. Airlines can lock in the price of jet fuel now and try to insulate themselves from a potential spike in prices next year.

So when you step into the middle of these transactions, and buy one of these contracts, you’re the one stuck with all the risk. And because commodity contracts typically let you control large amounts of gold, oil or soybeans with relatively little money, small price moves have a much bigger impact on your holdings. Those price moves can be extremely rapid and unpredictable — even for the pros. Just ask anyone who was holding gasoline futures this summer when prices plummeted. Those on the losing side of that bet lost a bundle.

That’s why you’ll have to demonstrate to a broker that you can afford to lose that bundle before they’ll let you open an account and begin trading. (If you tell them you’d be “sick if you lost” that money, you don’t meet the test, and no reputable broker will get you started.)

Still, commodities can be an important hedge against inflation — even if you have a relatively modest portfolio. The continuing strong growth in the global economy has created strong demand for a variety of raw materials – from oil to metals to lumber. That demand, in turn, puts upward pressure on the prices of those commodities. Since inflation can hurt other investments like stocks and bonds, some investment advisors recommend putting a small piece of your holdings in commodities. Think of it as your own hedge fund.

One alternative for individual investors is to buy shares in a commodities mutual fund or an Exchange Traded Fund that tracks individual indices or a basket of several commodities. Besides hedging your bets, ETFs can also lower the costs of diversifying into commodities.

But if it’s money you truly don’t want to lose, you’d better stick with Treasury bonds.

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