Part VII introduced commodities and their relation to equities over the business cycle, drawing on research done by the National Bureau of Economic Research (NBER). This part will focus on obtaining a basic understanding of the commodities themselves.
The publicly traded commodities can be classified into agricultural & livestock, energy, industrial metals, precious metals and timber.
Agriculture & Livestock
The major price movers in this space are weather-related events and changes in government policies. Coffee was lifted out of a three year bear market in early 2014 when a drought hit Brazil, the producer of 40% of the world’s coffee beans; it gained 117% in just six months. Sugar prices are heavily influenced by the trade barriers enacted in US and Europe. Some countries ban agricultural exports altogether. Major moves happen quite frequently in this space. Understanding these commodities and competing with the professional traders and speculators is out of the question. A better way to play this space would be through ETFs tracking agricultural commodities and their producers.
The most popular commodity is crude oil. Natural gas and ethanol are also traded, but as with the agricultural commodities, understanding their price movements is better left to the professional traders and speculators. It might surprise a few people to know that electricity is also traded via an electricity exchange, but again, this market is best left alone, which leaves us with crude oil.
Crude oil is not a commodity per se. There are variants depending on sulphur content and API gravity. API gravity is a measure of how light or heavy the crude oil is compared to water. Oil with low API gravity and high sulphur content is considered to be heavy oil, and oil with high API gravity and low sulphur content is considered to be light. Refineries are geared to refine a specific kind of crude oil; they cannot freely alternate between different types of crude oil. Oil prices quoted in the media refer to either WTI or Brent crude oil.
Copper is the most watched industrial metal. Copper prices indirectly signal the health of the global economy. A plunging copper price is a leading indicator of a recession. The other industrial metals traded are lead, zinc, nickel, molybdenum, aluminium, nickel, and cobalt.
Gold, silver and the Platinum Group Metals (PGMs) are classified as precious metals. The PGMs are a set of six metallic elements clustered together in the periodic table. Chemistry lesson aside, these are: ruthenium, rhodium, palladium, osmium, iridium and platinum. While it is possible to invest in all of them, we’ll stick to understanding just platinum and palladium. A key use for platinum and palladium is in catalytic converters in cars for pollution control. Platinum has also seen increased use in jewellery.
Gold and silver have several millennia of history as money. It was only in recent times that they were relegated from that role. Today, silver is more of an industrial metal with some investment demand, and its price fluctuations can be attributed to industrial demand factors, while gold is still mostly viewed as an investment and its price depends on investor sentiment.
The ETFs in this space track the companies engaged in the timber industry rather than the commodity itself. It is another commodity best left to the professionals.
In subsequent articles, we will explore certain commodities (oil, copper, gold, silver, platinum and palladium) in some depth, and armed with that understanding, take a look at various ways to invest in this space.