Investing in Commodities For Dummies. Amine Bouchentouf

The futures markets are administered by the various commodity exchanges, such as the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE). I discuss the major exchanges, the role they play in the markets, and the products they offer in Chapter 13.

      The most direct way of investing in the futures markets is to open an account with a futures commission merchant (FCM). The FCM is much like a traditional stock brokerage house (such as Schwab, Fidelity, or Merrill Lynch), except that it’s allowed to offer products that trade on the futures markets. Here are some other ways to get involved in futures:

      ✔ Commodity trading advisor (CTA): The CTA is an individual or company licensed to trade futures contracts on your behalf.

      ✔ Commodity pool operator (CPO): The CPO is similar to a CTA, except that the CPO can manage the funds of multiple clients under one account. This pooling provides additional leverage when trading futures.

      ✔ Commodity indexes: A commodity index is a benchmark, similar to the Dow Jones Industrial Average or the S&P 500, that tracks a basket of the most liquid commodities. You can track the performance of a commodity index, which allows you to essentially “buy the market.” A number of commodity indexes are available, including the Goldman Sachs Commodity Index and the Reuters/Jefferies CRB Index, which I cover in Chapter 12.

      

These examples are only a few ways to access the futures markets. Be sure to read Chapters 11 and 12 for additional methods.

      A number of organizations regulate the futures markets, including the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). These organizations monitor the markets to prevent market fraud and manipulation and to protect investors from such activity. Check out Chapter 13 for an in-depth analysis of the role these regulators play and how to use them to protect yourself from market fraud.

      

Trading futures isn’t for everyone. By their very nature, futures markets, contracts, and products are extremely complex and require a great deal of mastery by even the most seasoned investors. If you don’t feel that you have a good handle on all the concepts involved in trading futures, don’t simply jump into futures – you could lose a lot more than your principal (because of the use of leverage and other characteristics unique to the futures markets). If you’re not comfortable trading futures, don’t sweat it. You can invest in commodities in multiple other ways.

The equity markets

      Although the futures markets offer the most direct investment gateway to the commodities markets, the equity markets also offer access to these raw materials. You can invest in companies that specialize in the production, transformation, and distribution of these natural resources. If you’re a stock investor familiar with the equity markets, this may be a good route for you to access the commodities markets. The only drawback of the equity markets is that you have to take into account external factors, such as management competence, tax situation, debt levels, and profit margins, which have nothing to do with the underlying commodity. That said, investing in companies that process commodities still allows you to profit from the commodities boom.

Publicly traded companies

      The size, structure, and scope of the companies involved in the business are varied, and I cover most of these companies throughout the book. I offer a description of the company, including a snapshot of its financial situation, future growth prospects, and areas of operation. I then make a recommendation based on the market fundamentals of the company.

      You encounter these types of companies in the book:

      ✔ Diversified mining companies: A number of companies focus exclusively on mining metals and minerals. Some of these companies, such as Anglo-American PLC (NASDAQ: AAUK) and BHP Billiton (NYSE: BHP), have operations across the spectrum of the metals complex, mining metals that range from gold to zinc. I look at these companies in Chapter 9.

      ✔ Electric utilities: Utilities are an integral part of modern life because they provide one of life’s most essential necessities: electricity. They’re also a good investment because they have historically offered large dividends to shareholders. Read Chapter 5 to figure out whether these companies are right for you.

      ✔ Integrated energy companies: These companies, such as ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX), are involved in all aspects of the energy industry, from the extraction of crude oil to the distribution of liquefied natural gas (LNG). They give you broad exposure to the energy complex (see Chapter 6).

      

This list is only a small sampling of the commodity companies I cover in these pages. I also analyze highly specialized companies, such as coal-mining companies (Chapter 5), oil refiners (Chapter 6), platinum-mining companies (Chapter 7), and purveyors of gourmet coffee products (Chapter 10).

Master limited partnerships

      Master limited partnerships (MLPs) invest in energy infrastructure such as oil pipelines and natural gas storage facilities. I’m a big fan of MLPs because they’re a publicly traded partnership. They offer the benefit of trading like a corporation on a public exchange, while offering the tax advantages of a private partnership. MLPs are required to transfer all cash flow back to shareholders, which makes them an attractive investment. I dissect the structure of MLPs in Chapter 12 and introduce you to some of the biggest names in the business so you can take advantage of this unique investment.

Managed funds

      Sometimes it’s just easier to have someone else manage your investments for you. Luckily, you can count on professional money managers who specialize in commodity trading to handle your investments.

      Consider a few of these options:

      ✔ Exchange-traded funds (ETFs): ETFs are an increasingly popular investment because they’re managed funds that offer the convenience of trading like stocks. In recent years, a plethora of ETFs has appeared to track everything from crude oil and gold to diversified commodity indexes. Find out how to benefit from these vehicles in Chapter 12.

      ✔ Mutual funds: If you’ve previously invested in mutual funds and are comfortable with them, look into adding a mutual fund that gives you exposure to the commodities markets. A number of funds are available that invest solely in commodities. I examine these commodity mutual funds in Chapter 12.

      If you have a pet or a child, sometimes you hire a pet sitter or babysitter to look out after your loved ones. Before you hire this individual, you interview candidates, check their references, and examine their previous experience. When you’re satisfied with the top candidate’s competency, only then do you entrust that person with the responsibility of looking after your cat, daughter, or both. The same thing applies when you’re shopping for a money manager, or money sitter. If you already have a money manager you trust and are happy with, stick with him. If you’re looking for a new investment professional to look after your investments, you need to investigate him as thoroughly as possible. In Chapter 14, I examine the selection criteria to use when shopping for a money manager.

Physical commodity purchases

      The most direct way of