So you thought commodities were only good for a short time? You might be shocked to learn that commodities can be used as a long-term investment. Consider the following examples.
In 1971, gold saw its first major rise. Gold rose from $30 per ounce to $900 per ounce between 1971 and 1979. Gold rose sharply from $240/oz to $1900/oz between 2003 and 2011. Oil rallies are normally far shorter, but Brent's rise from $110 in August 2014 to $30 in February 2016 took 18 months. This has also been true for the majority of industrial metals. The underlying fact is that commodities, like stocks, have fairly extensive bull and down cycles, allowing for a long-term investment strategy. The question is whether to establish a long-term position on the spot market or on the commodity futures market.
Spot vs. futures market for long-term commodities
We've all heard about trading in the cash market versus trading in the equities futures market. But did you realise that there's a comparable separation between commodities and services?
Commodities can be purchased both on the spot and futures markets. You can buy gold in the spot market and take delivery, or you can buy gold in the futures market and decide on delivery before the contract expires. Commodity markets on the spot are far more complicated. If you buy gold on the spot market, for example, you must receive physical gold. Alternatively, you can buy gold futures and determine whether or not to take delivery before the expiration date. Gold futures will need to keep rolling over every month or quarter by paying the roll premium if they want to invest for the long term.
Let's take a look at the advantages and disadvantages of holding an investment position in important commodity classes.
Gold and silver are mostly regarded as investment commodities. In fact, they're seen as a form of insurance against market volatility. This is due to the fact that gold prices rise as geopolitical uncertainty rises. Long-term gold and silver investments should primarily serve to protect your financial portfolio from future economic concerns, as well as inflation and currency shocks.
Gold and silver have slightly different investment perspectives. While gold is a hedge against economic and geopolitical risk, silver sits in the middle of the precious metals and industrial metals spectrum. Hence, the economics driving silver are slightly different, and you need to factor it in.
Copper, Nickel, Zinc, Lead, and Aluminium are some of the most common industrial metals or base metals traded in Indian commodity exchanges. These base metals move in lockstep with industrial production in India and elsewhere. China is currently the largest user of these industrial metals, accounting for more than half of global consumption. These base metals are more vulnerable to news flows in terms of rally structure, and they're also popular for short- to medium-term trading. Investing in these base metals via futures, on the other hand, might be a profitable decision for people who wish to play out long-term cycles.
Crude oil and natural gas are two popular energy sources traded on Indian commodity exchanges. For a long time, basic metals were driven by demand, whereas energy was driven by supply. As energy becomes more demand-driven, this is changing. Oil can be particularly volatile due to supply, demand, and storage considerations, as well as global events. Precious metals offer a significant long-term investment opportunity, whereas base metals give a medium-term investment opportunity. Oil has followed trends as well, but these patterns and their time spans have been far too chaotic. Due to its volatility and vulnerability to government policy, traders, and investors prefer to take a view of 6-8 months at most on oil.
NCDEX dominates agro products trade, whereas MCX dominates energy, base metals, and precious metals trading. Monsoons, agricultural patterns, irrigation spread, and global supply dynamics are still a threat to agriculture. This is the fundamental reason why agricultural products are less investment-friendly. They're just good for short-term trading. Furthermore, government policy might be difficult to navigate because the government does not want agri-product prices to skyrocket for political reasons. These are either speculative investments or good hedging bets for farmers.
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