INVESTING IN COMMODITIES

Taamara de Silva explains how and why commodity trading is most important

Despite the lacklustre sentiments that prevailed towards commodities over the last few years, the COVID-19 pandemic has seen many investors turning to gold as well as other precious metals in a bid to find a safe haven from present vagaries.

From spices and silks traded centuries ago, commodities have certainly come a long way. They are now being traded on exchanges and have cemented their position as one of the preferred asset classes in many investment portfolios.

The impact of the SARS-Cov-2 novel coronavirus has been so profound that zero was no longer the bottom to which to sink. The demand for crude oil plummeted and the price of West Texas Intermediate (WTI) crude was seen trading at negative US$ 37 a barrel on 20 April 2020.

No one seemed to want the former magic potion of oil and those who were holding contracts didn’t want them; nor were they equipped to handle the delivery of thousands of barrels of the liquid gold.

Despite eventually recovering from its slump, this was a major stress test for oil – one that eventually led to widespread recalibration of many risk management frameworks.

Simply put, commodities are raw materials used to produce finished goods. These include agricultural products, mineral ores and fossil fuels – basically any kind of natural resource that is consumed by individuals and corporations.

Unlike securities such as stocks and bonds – which exist only as financial contracts – commodities are physical goods that are bought, sold and traded in markets. Commodities include energy, livestock, metals and agriculture.

Energy comprises the energy market, which includes oil, natural gas, coal and ethanol, and even uranium. It also includes forms of renewable energy such as wind power and solar power. Livestock consists of all live animals such as cattle and hogs.

Commodity metals comprise precious elements like gold, silver, palladium and platinum, as well as industrial metals like iron ore, tin, copper, aluminium and zinc.

Agriculture consists of edible goods such as cocoa, grain, sugar and wheat, as well as non-edible products such as cotton, palm oil and rubber.

In our day-to-day lives, we don’t pay much attention to where sugar and flour are grown or milled because both are commodities. While we may not realise it, commodities are now affecting all facets of society and fast becoming entwined in our lives.

It could be a car owner who needs to pump fuel into his or her vehicle, or a chef who has to buy meat to serve in a restaurant. So behind each product we use and every service we acquire, a big hand is being played by the commodities industry.

Prices for commodities are prone to shift constantly as supply and demand change predominantly on a global scale. For instance, a severe drought in India could lead to higher grain prices while a hike in oil production in the Middle East could depress the global price of black gold.

Commodity prices generally tend to pick up when there is a higher level of inflation and drop when inflation falls. As a result, investors tend to invest in commodities as a hedge against inflation and we can then expect a spike in commodity prices.

The question most investors ask is: where does one invest in 2021?

Former UN Secretary-General Ban Ki-moon once noted that “maritime transport is the backbone of global trade.” And commodities are the backbone of the global economy of today.

Though COVID-19 vaccines seem to be receiving approvals quicker than we expected, the speed at which they will be rolled out on a large scale is yet to be seen. However, from what we have witnessed so far, a strong rebound in economic growth is imminent with a higher focus on Asia.

What we must realise is that investing in commodities isn’t as simple as purchasing a barrel of oil or bar of gold. A more practical way to invest in commodities is to buy the stocks and bonds of commodity producers.

The other option is to look at mutual funds or exchange traded funds (ETFs) that are based on commodities. These funds combine the money from many small investors to build a large portfolio that attempts to track the price of a commodity or a basket of them. However, these instruments are yet to be introduced in Sri Lanka.

Looking at this year, we can expect renewed demand for energy and industrial metals as China increases its infrastructure investments. The agriculture sector may also reflect an upside as potential weather problems and food security measures by most nations continue to fuel demand overall. Gold, together with other precious metals, will remain bullish as central banks work to keep interest rates low.

Overall, substantial growth in money supply, record low interest rates and fiscal stimulus packages rolled out by many governments have boosted inflation expectations amid a weakening dollar. It’s safe to assume that commodities will have quite an impressive year in a post-pandemic world.