Have You Considered Commodities?
Some thoughts on why investing in commodities may (or may not) be best for you.
Over the last few weeks I’ve been talking about asset classes (“ Have you considered business? ” “ Have you considered real estate? ” and “ Have You Considered Paper Assets? ) and giving you the pros and cons of each. This week I want to discuss the last of the four asset classes—commodities.
There are many commodities that you can invest in. They include:
Agriculture (such as soybeans, wheat, milk, and cotton),
Livestock (such as cattle and hogs),
Energy (such as oil, natural gas, and ethanol),
Precious metals (such as gold, silver, platinum, and palladium), and
Industrial metals (such as copper, lead, zinc, and tin).
Commodities, along with the other asset classes, are a science unto themselves, and a whole book could be (and has been!) written on each of them.
So, let’s keep it simple and just focus on the few commodities many people are talking about today.
Silver has been a popular subject for the past few years. The public wasn’t talking about silver years ago, but today the price of silver pops up on the TV screen throughout the financial news shows. What makes silver so attractive?
Silver is a consumable commodity. It is used in the manufacture of things such as computers, cell phones, televisions, light bulbs, cars, mirrors, medicine, and water purification.
With the growth of emerging countries, the demand for silver should increase, even as the supply is dwindling.
In fact, for the first time in modern history, there is more gold available throughout the world than silver. It stands to reason that the price of silver should increase as the demand increases.
Gold is a tangible asset that has held its value throughout history. Gold is real money. A dollar bill, a peso, or a euro is not real money; they are currencies. What’s the difference? Real money has intrinsic value. Currency such as the US Dollar is backed only by a promise.
True money is always currency because it can be used to purchase other items that have value. Currency, however, is not always money because it does not have value by itself.
For example, pull a $20 bill or Euro note from your wallet. Do you think that piece of paper you are holding is really worth $20? No, the paper itself is probably worth about one cent. The only way a currency has value is because people have confidence in the government issuing the currency and a shared agreement that the currency is worth something. As confidences wanes, so does its value.
As a hedge against a weakened currency and inflation, gold can be a good investment.
Oil and Gas
The price of oil and gas is a popular subject. Oil and gas prices affect so many parts of our lives—plastics, food production, gasoline for our cars, airplane tickets, heating your home, etc.
As an investment, I’ve found it very important to differentiate between the types of oil and gas properties you can invest in. The four main categories are:
Producing: Drilling wells that are currently producing oil and gas. These provide the smallest return of the four types because there is little risk involved.
Proved developed: Oil and gas reserves are proven and drilling wells exist, however, they are not currently operating and producing. The returns are typically higher in a proved developed because the oil and gas are there and the wells are drilled. It’s simply a matter of getting into production.
Proven undeveloped: Oil and gas reserves are proven to exist, but there are no wells on the property. These will yield a stronger return on your investment because of the time and expense of getting the oil and gas out of the ground.
Exploratory: An area is being drilled to find oil and gas that has not yet been determined to exist. These provide both the highest risk and the highest potential for return.
The Pros of Commodities Investing
Easy entry: For example, buying gold and silver coins is very easy to do. If you can buy a loaf of bread, then you can buy gold and silver. Buying other commodities has the same level of ease as paper assets.
Increase in demand for raw material as economies grow: For example, with the growth of China and India, there is a greater demand for oil, gas, food, copper, and aluminum.
A hedge against inflation and a falling currency: When currencies fall in value, commodities usually rise. And when investors lose confidence in currencies, they may run to commodities, especially gold.
Tax advantages: Different commodities have varying degrees of tax advantages. Almost all are taxed at a lower rate than ordinary earned income or income from salaries and wages.
Home-based business: A child can easily buy a couple of silver coins and follow daily charts and graphs to check the current price. Involve your children as much as possible as you invest. What a great way for them to get started!
The Cons of Commodities Investing
No cash flow: Most, not all, commodities do not cash flow. They are a capital-gains investment.
No leverage: The average investor cannot borrow money to invest in commodities.
Dependent on the economy: As an economy slows, there is a decreased demand for raw materials.
Volatile: Commodities can be volatile with extreme ups and downs.
If you’re interested in commodities, as with any asset class, you need to know your stuff. Financial education is key.
Thankfully, you can start small and learn from both successes and mistakes. And there is a wealth of information out there to help you learn.
And the best news? You can start today!