Diversifying your portfolio – Investing in commodities
Author: Sunoor Kaul, Co-Founder, Origo Commodities
Diversifying your portfolio is one of the most important things you can do if you’re looking to lower your financial risk. Here, you can take advantage of the overwhelming stability that commodities offer. But what are commodities actually and why you need to invest in them? Commodities are all things that can be traded for consumption, processing or profit. They include everything from gold to coffee. In technical terms, they comprise economic goods that have considerable or complete fungibility.
When we think about commodities, the first few things that come to mind are usually assets like crude, gold, silver, copper, etc. However, by doing so, we miss the scope of other asset classes such as agricultural produce. In terms of supply and demand dynamics, agricultural products, or agri-commodities, typically have limited supplies while their demand is consistent and ever-growing. This facet presents investors with a critical asset class that can be used to make their investment portfolio well-rounded.
Why should you diversify into commodities?
It is important for investors to keep in mind that they need to diversify their investment portfolio whenever possible. This will help mitigate the risks associated with a single asset class while simultaneously providing them a positive impact on their portfolio’s overall performance. However, as with most financial products, you need to understand the underlying dynamics and risks associated with them before you commit your hard-earned money. In this case, there are several reasons why investing in agri-commodities is a great option.
Firstly, the prices of commodities move in correlation with each other. Although they may fluctuate drastically over short periods of time, over the long term they tend to trend higher owing to the seasonality of demand. Another advantage of investing in commodities is that you can use them as a hedge against inflation or deflation risk. Such purchases can also be made in the form of futures contracts, ETFs (Exchange-Traded Funds), or stock.
Types of commodities and how can you invest in them?
There are four main types of commodities, i.e. metals, livestock, energy, and agricultural produce. The metals segment consists of base metals such as copper, gold, silver, zinc, and lead.
Livestock includes the meat and dairy industries. The energy commodities sector consists of crude oil, natural gas, coal, and refined petroleum products like gasoline. Finally, agricultural produce consists of crops such as corn, wheat, soybeans, and sugar.
In terms of where you can invest in them, some of the mainstream places to do so are usually regulated by countries’ governments with jurisdictional rights. However, you can also do this by investing in commodity futures contracts such as gold futures, oil futures, or agriculture futures. Commodities can also be bought privately through individual stock options or ETFs that follow different asset classes.
Why should you invest in agri-commodities?
Agri-commodities are an important sector of the global economy, and their prices are a good reflection of supply and demand dynamics. They also constitute one of the most important asset classes because they are the backbone for global food production and consumption, and their demand and supply typically remain consistent unless there is an extreme weather event.
Today, a sea of change is being observed in the industry with the rise of institutional players in it. As a result, new avenues have been opened in the market with a robust supply chain. Now, given the infrastructural enhancements and a phenomenal digital influx across the board, investors can invest in the agri-commodities segment with considerable flexibility, transparency, and security.
We are also seeing the advent of new Pass-through Certificates (PTCs) in the segment which supports agri-commodity investment with a securitized process backed by receivables (to the tune of 10-11% per annum). Such PTCs further ease the participation as they eliminate the need to understand the market functions. At the same time, agri-fintech players are streamlining the end-to-end process from procurement and financing to storage and sale. They are helping ensure a higher price point of commodities for farmers while simultaneously decreasing the cost of purchase for investors by simply eliminating the prevalent inefficiencies in the entire value chain.
The agri-commodities sector is an undervalued asset class and remains to be one of the best opportunities to invest in future growth. Therefore, it is a good option for investors who wish to diversify their portfolios.