Commodities are the building blocks of industrial activity. Investors can trade commodities, such as oil, gold, copper or wheat, based on whether they think their prices will rise or fall. Investing in commodities is also an effective way to diversify an investment portfolio.
Discover what a commodity is and some of the reasons to invest in them. Learn about the different types of commodities and how to trade them.
Mastering the basics: a comprehensive guide to commodity trading
Commodity market prices are largely driven by “real world” buyers and sellers, such as multinational companies, that trade raw materials as part of their day-to-day business activity. Retail investors can also take a view on whether the price of a commodity will go up or down, without necessarily owning a physical barrel of oil or a bushel of wheat.
Tip: Commodities can be traded like any other asset using a standard brokerage account.
What are commodities?
A commodity is a natural resource or agricultural product that is mined, grown, reared or processed, and then used to produce more complex goods. The way in which commodities are standardised and interchangeable has resulted in the formation of dedicated commodity exchanges to support trading them.
Types of commodities
There are a wide range of commodities available, all grouped into one of several categories.
“Commodity markets tend to zig, when the equity markets zag.”Jim Rogers
Why trade commodities?
Most investors decide to buy and sell commodities because they believe their price will change. Trading in commodities is very similar to buying other assets, such as stocks. If you decide to open a long position and the price of your chosen commodity rises, you will be able to close the trade and make a profit.
Price moves in commodity markets can be long-term in nature. For example, the price of copper rose 156% between March 2020 and 2022, as economic production returned to normal after COVID-19 .
Past performance is not an indication of future results
Alternatively, price moves can occur as a short-term reaction to market events. In March 2022, the price of nickel rose 250% as a result of significant geopolitical events that investors believed would disrupt supplies.
There are other features of the commodity markets that make them popular with investors. Historical price charts demonstrate a low correlation between commodity and equity prices — when one goes up, the other often goes down. A diversified portfolio, split between the two asset classes could potentially experience less dramatic moves as a result.
Commodities are also popular because of their correlation with inflation. These assets are often used as a hedge against rising prices, with investors buying commodities to protect the purchasing power of their cash.
Past performance is not an indication of future results
How to trade commodities
The most user-friendly way of trading commodities is to use CFDs (Contract for Difference). CFDs are offered on many trading platforms and allow investors to directly trade oil, gas and coffee — among other commodities — without actually owning the underlying instrument. CFDs are versatile and enable traders to sell short, meaning they can potentially profit if the price of the commodity falls.
Alternatively, investors can buy the stocks of firms that are heavily linked to the commodity markets. For example, shares in oil and gas giant Shell Plc will closely track the price of energy sector commodities. A firm’s profits are driven by the value of the commodity assets it holds, processes and sells, and some investors prefer to gain indirect exposure to the commodity sector by investing in equities.
Tip: ETFs can offer a convenient and cost-effective way to start investing in commodities. Some ETFs, such as the iShares Silver Trust ETF, track the price of an underlying commodity. Others, such as the Global X Uranium ETF, hold stocks of firms involved with a particular commodity, in this case, uranium mining and the production of nuclear components.
What drives commodity prices?
Supply and demand help to drive the price of commodities. Interest rates, inflation levels and consumer confidence can all influence commodity prices.
Supply “shocks” can also trigger commodity price moves. Geopolitical events, such as wars, can disrupt supply lines, and bad weather can impact a harvest. Commodities investing also requires gaining an understanding of how the supply of commodities is difficult to change drastically — it is hard for suppliers to scale up production, even if price and demand increase. For example, it can take years for a new mine to start operating fully and the natural growing cycle of soft commodities will determine how quickly farmers can respond to price changes.
Many investors are interested in commodities because the assets themselves, as well as the factors that influence their price, are relatively easy to understand. As an asset class, they can offer a degree of diversification, a hedge against inflation and have a low correlation to stock prices. For those reasons, experienced investors will often include commodities in their investment portfolios.
Head to the eToro Academy to learn more about investing in commodities.
- Who invests in commodities?
Speculators, or retail investors, make up a large percentage of commodity investors. Between 2012 and 2022, it is estimated that there was a 100% increase in the volume of oil trades carried out by investors looking to make a return on their investment, rather than actually wanting to own and utilise crude oil. Often, the greater the number of speculators in a market, the higher the price volatility.
- How much does it cost to invest in CFD commodities?
Most brokers offer commission-free CFD trading. Instead, brokers make their money on the difference between the buy and sell price — the spread. CFDs do incur daily financing fees, however, which will need to be factored in by potential investors.
- What is the easiest commodity to trade?
Opening a CFD commodity trade is the same as it is for other CFD markets, and the process of investing in one commodity is no easier than investing in another. Instead, investors should consider the underlying features of the market. For example, the price of oil and copper will fluctuate in line with the wider economy, whereas soft commodity prices are more likely to be influenced by the weather.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.