Pay a premium over the spot price, whether purchasing coins or bullion. Premiums can range up to 25% of the spot prices. Pay cash for the total purchase price. If an investor wishes to leverage his purchase, he must find and negotiate with a private lender who is willing to accept the metal as collateral. Pay extra charges for storage and insurance to protect against theft. Assume the risks of illiquidity. Finding a buyer for a large amount of gold, for example, might be difficult and expensive[1] X Research source
For example, the World Gold Council maintains a list of reputable sites selling gold coins and bullion. [2] X Research source
Some gold-selling companies offer secure storage for buyers. [3] X Research source
A buy order is a contract to take delivery of the commodity while a sell order is a contract to make delivery of the commodity. Commodity futures and spot prices are tracked in the market just like other assets. Traders make money by buying commodities (or commodity derivatives) for a certain price and then subsequently selling them for a higher price. The buyer of a futures contract makes money if the future market price of the commodity exceeds the market price of the commodity at the time of purchase. A seller of a futures contract makes money if the future market price is less than the market price of the commodity at the time of sale. Rather than making or taking physical delivery of a commodity, futures traders close their positions by implementing a contrary position to offset their liability to make or take delivery. For example, a buyer of a contract would sell the contract before delivery date while the seller of a contract would buy the contract.
Commodities traders made trades based on two different types of analysis that they believe help them to predict commodity prices. The first, fundamental analysis, focuses on studying world events, like weather predictions, national and international political events, and trade patterns, to predict commodity prices. For example, a forecasted increase in air travel might lead a trader to believe the price of oil will go up with the increased demand. The second, technical analysis, focuses on analyzing historical price trends to predict future ones. It relies on identifying patterns, trends, and relationships in the market to predict prices. Price trends are the tangible result of the interplay between investors’ perceptions about supply and demand. Fundamental analysis is a guide to long-term prices while technical analysis reflects short term investor psychology. Visit the CME Group, which is a collection of four futures exchanges, at http://futuresfundamentals. cmegroup. com/ and review futures fundamentals.
Since the contracts are so large, small price movements have major impacts on profits or losses. If you own 1000 barrels of oil and the price increases or falls $1, it is about a 1. 2% move. However, it represents a 20% loss or profit on your investment[5] X Research source
Hedging is possible because the futures price and the spot price will be the same on the day the contract expires. To close its position, the food company would buy physical wheat on the spot market paying the market price while selling his futures contract at the same price. If the spot and futures price is $7. 00, the food company will pay $700,000 for his wheat on the spot market. However, having purchased 100,000 bushels on the futures market at $5. 50 ($550,000), he would close his futures position by selling the contact at $7. 00 ($700,000), making $150,000 to reduce his costs on the spot mark.
Recognize that the results you have with “paper trading” can be misleading since it does have not an emotional component. Being at risk to make or lose your investment complicates decision-making.
The fund team’s expertise should allow them to make choices that may make you money. Also, they have the expertise to knowledgeably diversify the investments, potentially moderating the risk of a single commodity holding. [6] X Research source
Clients are required to make minimum deposits of $5,000 to $10,000 in commodity accounts and are subject to initial and maintenance margin rules established by the commodity exchanges.
Options have significant profit potential due to the extreme leverage (the option represents a small percentage of the total value of the futures contract) and limited risk (the cost of the option). The option price tracks the price of the underlying futures contract which, in turn, tracks the price of the underlying commodity. For example, an option to buy a Dec Corn contract at $3. 50 a bushel will reflect the price of the futures option while the futures option will reflect the spot price of corn with a premium for the remaining duration period. If the spot price of corn is $3. 75, the futures price may be $4. 00 (the spot price plus a $0. 25 premium). In this case, the option price will be $0. 50 ($4. 00 - $3. 50) or more. Option holders usually liquidate their option positions rather than exercising them. Liquidation results when the holder of the option sells the option or the writer of the option buys the option (contrary transactions to the initial). [8] X Research source With options, you are not obligated to take or make delivery of the commodity with an option (called “exercising” the option). However, options expire on a specific date. [9] X Research source
Writing a futures option means assuming the risk of delivering a futures contract to the option buyer. While writing a futures options can be more profitable than buying an option, the writer also assumes the greater risk that the option might be exercised, requiring the writer to deliver the futures contract. The price of a futures option depends upon the volatility of the prices of the underlying commodity as well as the term of the option. Premiums are highest when the strike price is near the spot price and the time value (duration or length of period during which the option can be exercised) is long. Futures options can be sold when the strike price is far out of the money and unlikely to be exercised. As a consequence, short term price moves of the futures contract have less impact on the options price.
Options spreads may allow you to offset the cost of your investment by selling options to other investors while you purchase options for a later date.
Commodity stock prices will not move directly with commodity prices and may be influenced by other factors like company performance or underlying reserve values. Stocks are far less volatile than futures and they are easy to buy and sell. You could also consider buying mutual funds that invest in a variety of commodity-related stocks. [10] X Research source Stocks and bonds are long term and have no expiration date like those of commodities or options.
Commodity-related stocks can be analyzed fundamentally or technically. Use fundamental analysis to determine if the company is a good value and likely to prosper in the future. Once you’ve chosen a stock, identify buying opportunities by watching the price movements of the stock to determine the optimum purchase and sale opportunities. [11] X Research source
Cash and margin accounts are available. The latter provides an ability to sell stocks short as well as the ability to borrow money from the brokerage firm. Be aware that leverage increases the profit potential of a trade as well as its risk. When buying stocks of any kind, diversification reduces the risk of loss present in a single company. Consider buying multiple companies in the same industry to reduce the risk of owning a single company; buy companies in different industries to reduce the risk of owning a single industry.
Mutual funds let investors participate in the commodities market without having to get directly involved with trading highly leveraged commodities. Also, since commodity mutual funds also make investments in stocks related to the commodities, sometimes they still perform well even if a commodity itself is experiencing a negative price movement. For example, stocks in a mining company may rise even though the price of the commodity they mine is falling. This is because the stock value of the companies related to the commodities are affected not only by the price of the commodity, but also by their own debt and cash flow. [13] X Research source Major investment companies that sell commodity index funds include Pimco Real Return Strategy Fund, Oppenheimer, Barclays and JP Morgan. Commodity mutual funds are advantageous because they are professional managed and diversified, providing a full package to inexperienced investors. [14] X Research source
Commodity ETFs trade like a common stock on a stock exchange and undergo price changes frequently as they are bought and sold. ETFs usually have lower fees than mutual fund shares. However, ETFs also introduce credit risk, as their issuer may not be able to repay the promised amount under certain circumstances. [15] X Research source
