Investing in Commodities For Dummies. Amine Bouchentouf

first agricultural products grown by man. It’s an essential staple of human life and makes for a great investment.

      ✔ Soybeans: Soybeans have many applications, including as feedstock and for cooking purposes. The soybean market is a large market and presents some good investment opportunities.

      ✔ Soybean oil: Soybean oil, also known as vegetable oil, is derived from actual soybeans. It’s used for cooking purposes and has become popular in recent years with the health-conscious dietary movement.

      ✔ Soybean meal: Soybean meal is another derivative of soybeans that’s used as feedstock for poultry and cattle. It may not sound sexy, but it can be a good investment.

      ✔ Live cattle: For investors involved in agriculture, using the live cattle futures contract to hedge against price volatility is a good idea.

      ✔ Feeder cattle: Whereas the live cattle contract tracks adult cows, the feeder cattle contract hedges against the risk associated with growing calves. The markets don’t widely follow this area, but it’s important to figure out how this market works.

      ✔ Lean hogs: They may not be the sexiest commodity out there, but lean hogs are an essential commodity, making them a good trading target.

      ✔ Frozen pork bellies: Frozen pork bellies are essentially nothing more than good old bacon. This industry is cyclical and subject to wild price swings, which provides unique arbitrage trading opportunities.

      Chapter 2

      The Pros and Cons of Commodities

       In This Chapter

      ▶ Examining strong reasons to consider commodities

      ▶ Acknowledging the inherent downsides

      ▶ Managing risk when investing in commodities

      Commodities have traditionally been considered the black sheep in the family of asset classes; for several decades, no respectable money manager wanted anything to do with them. This traditional lack of interest (which no longer applies, by the way) has generated a lot of misinformation about commodities. As a matter of fact, probably no other asset class has suffered through so much misunderstanding and misconception.

      Many investors are scared of venturing into the world of commodities. For one thing, it seems that every time the word commodities is uttered, someone pops up with a horrible story about losing their entire life savings trading soybeans, cocoa, or some other exotic commodity. Even though this negative perception is rapidly changing, commodities are still often misunderstood as an investment. I actually know some investors who invest in commodities (and who have made money off them) but who don’t understand the fundamental reasons commodities are such a good long-term investment.

      In this chapter, I show you why commodities are an attractive investment and why many investors are becoming more interested in this asset class. Then again, I believe that many investors are afraid of commodities because they don’t know much about them. My further aim in this chapter is to shed some light on the issues surrounding commodities so that you can invest with confidence. I’m not denying that commodities present some risk – all investments do. And so I give you some tools to minimize and manage those risks.

      Why the 21st Century Is the Century of Commodities

      Since autumn 2001, commodities have been running faster than the bulls of Pamplona. The Reuters/Jefferies CRB Index (a benchmark for commodities) nearly doubled between 2001 and 2006. During this period, oil, gold, copper, and silver hit all-time highs (although not adjusted for inflation). Other commodities also reached levels never seen before in trading sessions.

      Many investors wondered what was going on. Why were commodities doing so well when other investments, such as stocks and bonds, weren’t performing? I believe that we’re witnessing a long-term cyclical bull market in commodities. Because of a number of fundamental factors (which I go through in the following sections), commodities are poised for a rally that will last well into the 21st century – and possibly beyond that. It’s a bold statement, I know. But the facts are there to support me.

      

Although I’m bullish on commodities for the long term, I have to warn you that at times commodities won’t perform well at all. This statement is simply the nature of the commodity cycle. Furthermore, in the history of Wall Street, no asset has ever gone up in a straight line. Minor (and, occasionally, major) pullbacks always happen before an asset makes new highs – if, in fact, it does make new highs.

      Consider an example. During the first few months of 2006, commodities outperformed every asset class, with some commodities breaking record levels. Gold and copper both hit a 25-year high. Then during the week of May 15, commodities saw a big drop. The Reuters/Jefferies CRB Index fell more than 5 percent that week, with gold and copper dropping 10 and 7 percent, respectively.

      Many commentators went on the offensive and started bashing commodities. “We are now seeing the beginning of the end of the rally in commodities,” said one analyst. A newspaper ran the headline “Is This the End of Commodities?” An endless number of commentators hit the airwaves claiming that this was a speculative bubble about to burst. A respected economist even compared what was happening to commodities to the dotcom bubble: “There is no fundamental reason why commodity prices are going up.” Nothing could be further from fact. A couple weeks after this minor pullback, some of these commodities that were being compared to highly leveraged tech stocks had regained most, if not all, of their lost ground. Even after the GFC, most commodities are now back to their precrisis levels, with many others making all-time highs.

      There’s a story behind the rise in commodities – and it’s a pretty compelling one.

Ka-boom! Capitalizing on the global population explosion

      The 21st century is going to experience the largest population growth in the history of humankind. The United Nations (UN) estimates that the world will add a little less than 1 billion people during each of the first five decades of the 21st century. The global population will grow to about 9 billion people by 2050 (as of 2015, approximately 7.3 billion people live on the planet).

      Also consider the following statistic: According to the UN, the average number of years it takes to add 1 billion people has shrunk from an average of 130 years in the 19th century to approximately 13 years in the 21st century! The rate at which the human population is increasing has reached exponential levels.

      So how is this relevant to commodities? Put simply, significant population growth translates into greater global demand for commodities. Humans are the most voracious consumers of raw materials on the planet – and the only ones who pay for them. As the number of humans in the world increases, so will the demand for natural resources. After all, people need food to eat, houses to live in, and heat to stay warm during the winter – all of this requires raw materials. This large population growth is a key driver for the increasing demand for commodities, which will continue to put upward pressure on commodity prices.

Profiting from urbanization

      Perhaps even more significant than population growth is the fact that it’s accompanied by the largest urbanization movement the world has ever seen. In the early 20th century, according to the UN, less than 15 percent of the world’s population lived in cities; by 2005, that number jumped to 50 percent – and still shows no sign of decreasing. As a matter of fact, 60 percent of the world’s population is expected to live in urban areas by the year 2030.

      Urbanization is highly significant for commodities because people who live in urban centers consume a lot more natural resources than those who live in rural areas. In addition, more natural resources are required to expand the size of cities as more people move to them (rural to urban migration) and have more kids (indigenous urban population growth). More natural resources are required for the roads, cars, and personal appliances that are staples of city life.

      

Industrial metals such as copper, steel, and aluminum are going to be