Investing in Commodities For Dummies. Amine Bouchentouf

however, I recommend that you read Parts I and II carefully before you start skipping around in the chapters on particular commodities.

Part I

      Just the Facts on Commodities

      

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       In this part …

      ✔ Know why you should invest in commodities, check out the commodities markets, and find the best ways to invest in commodities

      ✔ Celebrate the advantages, acknowledge the downsides, and manage risk when investing in commodities

      Chapter 1

      Investors, Start Your Engines! An Overview of Commodities

       In This Chapter

      ▶ Finding out why you should invest in commodities

      ▶ Defining the commodities markets

      ▶ Determining the best ways to trade commodities

      ▶ Identifying the major commodities

      The commodities markets are broad and deep, presenting both challenges and opportunities. Investors are often overwhelmed simply by the number of commodities out there: more than 30 tradable commodities to choose from. (I cover almost all of them – 32, to be exact – more than any other introductory book on the topic.) How do you decide whether to trade crude oil or gold, sugar or palladium, natural gas or frozen concentrated orange juice, soybeans or aluminum? What about corn, feeder cattle, and silver – should you trade these commodities as well? And if you do, what’s the best way to invest in them? Should you go through the futures markets, go through the equity markets, or buy the physical stuff (such as silver coins or gold bullion)? And do all commodities move in tandem, or do they perform independently of each other?

      With so many variables to keep track of and options to choose from, just getting started in commodities can be daunting. Have no fear – this book provides you with the actionable information, knowledge, insight, and analysis to help you grab the commodities market by the horns. You’ve maybe heard a lot of myths and fantasies about commodities. I shatter some of these myths and, in the process, clear the way to help you identify the real money-making opportunities.

      For example, a lot of folks equate (incorrectly) commodities exclusively with the futures markets. Undoubtedly, the two are inextricably linked – the futures markets offer a way for commercial users to hedge against commodity price risks and a means for investors and traders to profit from this price risk. However, the futures market is only one planet in the commodities universe.

      The equity markets are also involved in commodities. Companies such as ExxonMobil (NYSE: XOM) focus on the production of crude oil, natural gas, and other energy products; Anglo-American PLC (NASDAQ: AAUK) focuses on mining precious metals and minerals across the globe; and Starbucks (NASDAQ: SBUX) offers investors access to the coffee markets. Ignoring these companies that process commodities isn’t only narrow minded, but it’s also a bit foolish because they provide exposure to the very same commodities traded on the futures market.

      In addition to the futures and equity markets, a number of investment vehicles allow you to access the commodities markets. These vehicles include master limited partnerships (MLPs), exchange-traded funds (ETFs), and commodity mutual funds (all covered in Chapter 12). So although I do focus on the futures markets, I also examine investment opportunities in the equity markets and beyond.

      The commodities universe is large, and investment opportunities abound. In this book, I help you explore this universe inside and out, from the open outcry trading pits on the floor of the New York Mercantile Exchange to the labor-intensive cocoa fields of the Ivory Coast; from the vast palladium-mining operations in northeastern Russia to the corn-growing farms of Iowa; from the Ultra Large Crude Carriers that transport crude oil across vast oceans to the nickel mines of Papua New Guinea; from the sugar plantations of Brazil to the steel mills of China.

      By exploring this fascinating universe, not only do you get insight into the world’s most crucial commodities – and get a glimpse of how the global capital markets operate – you also see how to capitalize on this information to generate profits.

      Defining Commodities and Their Investment Characteristics

      Just what, exactly, are commodities? Put simply, commodities are the raw materials humans use to create a livable world. Humans have been exploiting earth’s natural resources since the beginning of time. They use agricultural products to feed themselves, metals to build weapons and tools, and energy to sustain themselves. Energy, metals, and agricultural products are the three classes of commodities, and they are the essential building blocks of the global economy.

      For the purposes of this book, I present 32 commodities that fit a very specific definition, which I define in the following bulleted list. For example, the commodities I present must be raw materials. I don’t discuss currencies – even though they trade in the futures markets – because they’re not a raw material; they can’t be physically used to build anything. In addition, the commodities must present real moneymaking opportunities to investors.

      All the commodities I cover in the book have to meet the following criteria:

      ✔ Tradability: The commodity has to be tradable, meaning that there needs to be a viable investment vehicle to help you trade it. For example, I include a commodity if it has a futures contract assigned to it on one of the major exchanges, if a company processes it, or if an ETF tracks it.

      Uranium, which is an important energy commodity, isn’t tracked by a futures contract, but several companies specialize in mining and processing this mineral. By investing in these companies, you get exposure to uranium.

      ✔ Deliverability: All the commodities have to be physically deliverable. I include crude oil because it can be delivered in barrels, and I include wheat because it can be delivered by the bushel. However, I don’t include currencies, interest rates, and other financial futures contracts because they’re not physical commodities.

      ✔ Liquidity: I don’t include any commodities that trade in illiquid markets. Every commodity in the book has an active market, with buyers and sellers constantly transacting with each other. Liquidity is critical because it gives you the option of getting in and out of an investment without having to face the difficulty of trying to find a buyer or seller for your securities.

      Going for a Spin: Choosing the Right Investment Vehicle

      The two most critical questions to ask yourself before getting started in commodities are the following: What commodity should I invest in? How do I invest in it? I answer the second question first and then examine which commodities to choose.

The futures markets

      In the futures markets, individuals, institutions, and sometimes governments transact with each other for price-hedging and speculating purposes. An airline company, for instance, may want to use futures to enter into an agreement with a fuel company to buy a fixed amount of jet fuel for a fixed price for a fixed period of time. This transaction in the futures markets allows the airline to hedge against the volatility associated with the price of jet fuel. Although commercial users are the main players in the futures arena, traders and investors also use the futures market to profit from price volatility through various trading techniques.

      

One such trading technique is arbitrage, which takes advantage of price discrepancies between different futures markets. For example, in an arbitrage trade, you purchase and sell the crude oil futures contract simultaneously in different trading venues, for the purpose of capturing price discrepancies between these venues.